TaxAwareAA: TaxAwareAA: A package for performing tax-aware asset...
In rexmacey/TaxAwareAA: Tax Aware Asset Allocation
Description
TaxAwareAA attempts to both allocate and locate assets in a mean-variant
efficient manner. Its main functions include a function to create tax
efficient, efficient frontiers and to create a portfolio with a target
standard deviation that is efficient using resampling. These are
efficient.frontier and resample.target.risk.
Details
To perform a tax aware asset allocation we need to have a set of assumptions
about the assets (also called asset classes in this documentation). These
set of assumptions are put in an object called a cma (capital market
assumptions). For clarity, we refer to the base, non-tax-adjusted set of
capital market assumptions as a cma. If tax-adjusted we will use cma.ta. We
also need to know something about the investor. We use an object called
investor. We can combine a cmf and an investor into a tax-aware capital
market assumption object, the cma.ta.
We assume a set of returns and covariance matrix for a set of asset classes
just as we would in a non-tax-aware exercise. Additional information on the
nature of the asset classes is required so that we can calculate the impact
of taxes. For example, we need the yield on each asset and the character of
the income it generates (ordinary income, tax-free income, qualified
dividend).
We assume the investor has assets in three types of accounts:
- Taxable
An account in which income and capital gains are subject to
tax. Example, a brokerage account for an individual.
- Deferred
An
account that is taxed when the assets are withdrawn. Example, an IRA.
- Exempt
An account which is not subject to tax. Example, a Roth IRA
We know amounts the investor has in each type of account. Further, we know
the rates at which income, capital gains and qualified dividends are taxed.
To create a tax-aware cma, we triple the number of asset classes of the base
cma. We would have each of the base asset classes in each of the three
account types and treat them separately. So if there were just bonds and
stocks in the base cma, in a tax-aware cma we have six asset classes.
The (after-tax) returns of the assets differ depending on their location.
There are arguments that the variance of the assets should also change, but
this version does not address that. The argument for adjusting the risk is
that in the face of taxes, the government reduces the gain (or loss) thus
reducing the variability. It is the author's opinion that covariance
matrices, especially generated on historical data, understate the risk which
most investor's care about which is downside risk in a crisis. Historically
based covariance underestimates the higher volatility and correlations that
often occur in a crisis. This is something to consider in future versions.
The author has chosen to address this in the future. Since the user
specifies tne covariance matrix, the user may supply one that considers the
impact of taxes.
This tax-aware optimization is similar to a non-tax aware. We use 3x the
number of assets (N). The first N assets are those in the taxable account.
The second N are in the deferred. The last N are in the exempt account. We
add constraints so the the weights in each match the proportions of the
assets by account type. The user may specify constraints by base asset
class. For example, if the first asset clas has a maximum weight of 25
then this model introduces the constraint that the sum of the weights of
class [1] + class [N+1] + class [2N+1] <= 0.25
The results is a set of weights across the 3N asset classes.
About the Investor
Author(s)
Rex Macey, rex@macey.us
rexmacey/TaxAwareAA documentation built on Dec. 3, 2019, 7:54 a.m.
R Package Documentation
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Description
TaxAwareAA attempts to both allocate and locate assets in a mean-variant efficient manner. Its main functions include a function to create tax efficient, efficient frontiers and to create a portfolio with a target standard deviation that is efficient using resampling. These are efficient.frontier and resample.target.risk.
Details
To perform a tax aware asset allocation we need to have a set of assumptions about the assets (also called asset classes in this documentation). These set of assumptions are put in an object called a cma (capital market assumptions). For clarity, we refer to the base, non-tax-adjusted set of capital market assumptions as a cma. If tax-adjusted we will use cma.ta. We also need to know something about the investor. We use an object called investor. We can combine a cmf and an investor into a tax-aware capital market assumption object, the cma.ta.
We assume a set of returns and covariance matrix for a set of asset classes just as we would in a non-tax-aware exercise. Additional information on the nature of the asset classes is required so that we can calculate the impact of taxes. For example, we need the yield on each asset and the character of the income it generates (ordinary income, tax-free income, qualified dividend).
We assume the investor has assets in three types of accounts:
- Taxable
An account in which income and capital gains are subject to tax. Example, a brokerage account for an individual.
- Deferred
An account that is taxed when the assets are withdrawn. Example, an IRA.
- Exempt
An account which is not subject to tax. Example, a Roth IRA
We know amounts the investor has in each type of account. Further, we know the rates at which income, capital gains and qualified dividends are taxed.
To create a tax-aware cma, we triple the number of asset classes of the base cma. We would have each of the base asset classes in each of the three account types and treat them separately. So if there were just bonds and stocks in the base cma, in a tax-aware cma we have six asset classes.
The (after-tax) returns of the assets differ depending on their location. There are arguments that the variance of the assets should also change, but this version does not address that. The argument for adjusting the risk is that in the face of taxes, the government reduces the gain (or loss) thus reducing the variability. It is the author's opinion that covariance matrices, especially generated on historical data, understate the risk which most investor's care about which is downside risk in a crisis. Historically based covariance underestimates the higher volatility and correlations that often occur in a crisis. This is something to consider in future versions. The author has chosen to address this in the future. Since the user specifies tne covariance matrix, the user may supply one that considers the impact of taxes.
This tax-aware optimization is similar to a non-tax aware. We use 3x the number of assets (N). The first N assets are those in the taxable account. The second N are in the deferred. The last N are in the exempt account. We add constraints so the the weights in each match the proportions of the assets by account type. The user may specify constraints by base asset class. For example, if the first asset clas has a maximum weight of 25 then this model introduces the constraint that the sum of the weights of class [1] + class [N+1] + class [2N+1] <= 0.25
The results is a set of weights across the 3N asset classes.
About the Investor
Author(s)
Rex Macey, rex@macey.us
R Package Documentation
Browse R Packages
We want your feedback!
Note that we can't provide technical support on individual packages. You should contact the package authors for that.
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