In life, two things are certain.......

Death and Taxes.

I'll leave the discussion on death for another post and talk a little bit about taxes and how to bake in tax efficiency into your portfolio

The bottom line is that taxes can eat away a big chunk of your investment returns over the long term (more so if you happen to be in a high tax bracket). Keeping the following in mind when creating a portfolio can soften the blow....

For investments held in the US -

# Hold your Bond allocation inside of a tax deferred account like a 401K or IRA. This is because dividends accrued from bond funds are taxed at your highest marginal rate (treated as ordinary income).
# Along the same lines, if you hold small cap funds or value funds or REITS (real estate funds) that dish out large capital gains distributions every year - hold them in a tax deferred account for the same reason as 1 above
# If you have taxable accounts (non-IRA or 401K or ROTH), hold your large cap/index funds (tax efficient) in there.
# Evaluate whether investing your cash/bond allocation in Tax exempt Municipal bond funds or Tax exempt Money market funds is advisable (based on your tax bracket). It makes sense to invest in a tax exempt instrument if
(tax exempt return)/(1 - marginal tax rate/100) > regular taxable return
So if your marginal tax rate is 35% then a tax exempt muni yielding 3% gives you a better after tax rate that a 4% Fixed deposit since by using the formula above, the REAL return after taxes is equivalent to that of a CD yielding 4.6%. On the other hand, if you find a CD yeilding greater than 4.6% - go for that instead of the 3% muni.
# When rebalancing your long term portfolio (which involves selling/buying), try to do so inside a 401K or rebalance with fresh money (buying only - no selling). This way, no taxes will need to be paid just because you are rebalancing your portfolio.

I'll talk thru tax saving techniques in the Indian Market in a later post.