returns that accrue to the investor rather than the IRS. Mr. Street is a successful equity portfolio manager. Over the past 15 years his portfolios have returned 12 percent per year while the market has returned only 10 percent. Mr. Street claims to be tax efficient because his annual turnover is only 30 percent. Would a taxable investor have benefited from Mr. Street's services or would the investor have been better off in an index fund? To answer that we must ascertain (1) whether the investor would have held the stock in a taxable or tax-advantaged account and (2) whether the investor expected to eventually sell the portfolio and pay capital gains tax or dispose of the assets through death or charitable giving, thus avoiding capital gains tax. All or most of the additional return created by Mr. Street's portfolio management skill would have accrued to the investor if the assets were held in a tax-free entity such as a foundation or a tax-deferred retirement account. Turnover and realization of gains has no tax impact in these entities. The outcome would be different if the portfolio was subject to direct taxation. Ten percent out of the 12 percent annual return came just from being in the market. Mr. Street deserves credit only for the extra 2 percent return. In order to earn that additional return, Mr. Street periodically turned over the portfolio, subjecting all the appreciation to capital gains tax. Thirty percent annual turnover implies about a three-year average holding period. Three years is not very long, so a taxable investor who hires Mr. Street should accept the fact that, over time, substantially all appreciation will be subject to capital gains tax. This is very different from a buy-and-hold index strategy that would have allowed the 10 percent return to compound on a pretax basis. The index fund would have returned more on an after-tax basis. We present three tables that compare the growth of a portfolio assuming 9 percent annual appreciation and a 1 percent dividend yield. Table 32.1 reflects a passive strategy. We assigned a 5 percent annual turnover to reflect unavoidable turnover due to mergers, acquisitions, and benchmark changes. Table 32.2 reflects active management with 30 percent TABLE 32.1 Portfolio Growth and Return for Buy-and-Hold 9% annual appreciation; 1% dividend yield; 5% turnover Annualized After-Tax Return   Year Dividend Realized Gain Tax Market Value Cost Basis Bequest Liquidati'         $1,000,000 $1,000,000     1 $10,000 $ 4,500 $ 4,900 1,095,100 1,009,600 9.51% 7.80% 2 10,951 9,203 6,221 1,198,389 1,023,533 9.47 7.86 3 11,984 14,136 7,621 1,310,607 1,042,032 9.44 7.92 4 13,106 19,327 9,108 1,432,560 1,065,357 9.40 7.97 5 14,326 24,807 10,692 1,565,125 1,093,797 9.37 8.02 10 22,219 57,809 20,449 2,423,633 1,325,265 9.26 8.22 15 34,248 104,360 34,571 3,732,739 1,749,893 9.18 8.36 20 52,622 172,458 55,541 5,732,896 2,456,188 9.12 8.46 25 80,720 274,187 87,125 8,792,064 3,582,505 9.08 8.54