Investing term

What is Tax drag?

The return reduction from realising taxable gains when you sell winners to rebalance.

Tax drag is the reduction in returns caused by paying taxes on gains and income along the way — for instance, when selling winners to rebalance triggers a taxable gain. Money paid in tax can no longer compound for you, so frequent realized gains and high turnover quietly erode long-run wealth. Tax-aware investing and using tax-advantaged accounts limit the drag.

For example

Selling a winner to rebalance in a taxable account triggers a tax bill that, taken every year, can shave a noticeable amount off long-run returns.

Tax drag is taught hands-on in Stage 18 — Rebalancing & Maintenance.

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Related terms

5/25 ruleRebalance any sleeve that has drifted more than 5 percentage points absolute, or 25% relative, from its target weight.Calendar ruleRebalance on a fixed schedule (e.g. annually) regardless of how far the portfolio has drifted.New-money rebalancingBringing the portfolio back to target by directing new contributions into underweight sleeves, rather than selling overweight ones.Rebalancing premiumThe small return boost a disciplined rebalancer earns over a buy-and-drift portfolio, by systematically selling high and buying low.
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