Comparing After-tax Rates of Return on Investments [Video]

Not all types of income are taxed at the same rate; income from certain investments is taxed at a preferential rate. Thus, when comparing investments, it’s important to consider the after-tax return of the investment instead of simply looking at the before-tax return.

The after-tax return is calculated as follows:

after-tax return = before-tax return x (1 – marginal tax rate)

For example, let’s consider a corporate bond that pays 6% interest and a tax-exempt municipal bond that pays 4% interest. If the interest income from the corporate bond is taxed at a rate of 35%, then the after-tax return of the corporate bond is just 3.9%. Think about this way: if you invested $100 in the corporate bond you would receive $6 of interest annually, but that $6 of income would be taxed at a rate of 35%, resulting in taxes of $2.10 ($6 x 35%). Thus, you received $6 of interest but after paying taxes on that income you were left with just $3.90. The municipal bond, on the other hand, is tax-exempt which means the tax rate on interest earned from the municipal bond is zero. Thus, if you invested $100 in the municipal bond you would receive just $4 of interest but you would get to keep the entire $4 (since the tax rate is 0%). Thus, the municipal bond would have a higher after-tax rate of return even though the corporate bond would have a higher before-tax rate of return.
—
Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education freely available to the world.
—
SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS:
• A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING
• A 44-PAGE GUIDE TO U.S. TAXATION
• A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS
• MANY MORE FREE PDF GUIDES AND SPREADSHEETS
* http://eepurl.com/dIaa5z
—
SUPPORT EDSPIRA ON PATREON
*https://www.patreon.com/prof_mclaughlin
—
GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT
* https://edspira.thinkific.com
—
LISTEN TO THE SCHEME PODCAST
* Apple Podcasts: https://podcasts.apple.com/us/podcast/scheme/id1522352725
* Spotify: https://open.spotify.com/show/4WaNTqVFxISHlgcSWNT1kc
* Website: https://www.edspira.com/podcast-2/
—
GET TAX TIPS ON TIKTOK
* https://www.tiktok.com/@prof_mclaughlin
—
ACCESS INDEX OF VIDEOS
* https://www.edspira.com/index
—
CONNECT WITH EDSPIRA
* Facebook: https://www.facebook.com/Edspira
* Instagram: https://www.instagram.com/edspiradotcom
* LinkedIn: https://www.linkedin.com/company/edspira
—
CONNECT WITH MICHAEL
* Twitter: https://www.twitter.com/Prof_McLaughlin
* LinkedIn: https://www.linkedin.com/in/prof-michael-mclaughlin
—
ABOUT EDSPIRA AND ITS CREATOR
* https://www.edspira.com/about/
* https://michaelmclaughlin.com