Tax Management
Target market segments such as value stocks and small cap stocks have higher expected returns than their growth and large cap counterparts, but they can be costly for taxable investors. Recognizing that clients are tax sensitive, Dimensional has developed a tax management overlay. The funds deliver consistent pre-tax exposure to the targeted asset classes for tax-deferred accounts, with a special emphasis on maximizing after-tax returns for taxable investors.
Like other tax-managed portfolios, Dimensional's strategies offset capital gains and losses, but that is only the beginning. Equity portfolios generate dividends that traditional tax management typically ignores—in spite of the fact that taxes on dividends from US and international companies are significantly higher than taxes from capital gains in those regions. The challenge is to reduce dividends without diluting exposure to the factors that drive returns. Dimensional's tax-managed strategies simultaneously attempt to minimize taxable gains and dividend yields while targeting strong asset class exposure and solid, broad diversification.
The benefits of reducing dividends from US and international companies will also acrue to investors that hold the funds inside their RRSP or other tax-deferred accounts. This income is subject to foreign withholding tax. However, the investor does not receive a foreign tax credit if the funds are held in a retirement plan or other tax-deferred account. Consequently, US and international dividend income is effectively taxed, even though the funds are held in a tax-deferred account. Reducing dividend income thereby eliminates the effects of foreign withholding tax and maximizes the benefits of tax-deferred compounding in registered plans.