Tax Equivalent Yield

Jul 13, 2020 11:24:26 AM / by Michael Dailey

Tax Equivalent Yield

 

It is often the things we don’t know that can cost us the most…

Tax Equivalent Yield is one of those things most investors don’t know or think about, but it can cost you plenty. The good news? Tax Equivalent Yield is monitored by InvestorKeep. 

Tax-equivalent yield (or return) is the pretax return a taxable bond should provide for its return to be equal to that of a tax-free municipal bond.  In other words, it is the return you’d have to receive for your taxable bond to be equal to a non-taxable bond. Using tax-equivalent yield allows for an apples-to-apples comparison between the yield of a tax-free bond to that of a taxable bond.

For example, your financial professional may give you two options. A corporate bond that pays you 6% or a municipal bond that pays you 4.5%. Naturally, you would want the higher rate, but the corporate bond requires you to pay taxes. Assuming equal risk, what are the implications of tax treatment? We can compare the corporate bond to the municipal bond using the tax equivalent yield formula:

tax-yield-formula

Assuming a 30% tax rate: 4.5%/ (1-.3) = 6.43%. The municipal bond has a better return than the corporate bond due to taxes.  The .43% difference on $100,000 is $430!  These small changes in returns, reinvested add up to significant increases over the lifetime of an investment.

 

 

Michael Dailey

Written by Michael Dailey

Michael Dailey is the Founder and CEO of InvestorKeep, a company passionate about help you save money and maximize your investments. The average investor loses well over $100K to the implications of investment fit, fees, and quality. InvestorKeep gives you an easy way to monitor investments helping you keep and earn more.