Impact of Taxes and Fees on a Portfolio

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1 Presented by QQQ TM

2 Impact of Taxes and Fees on a Portfolio Also inside: 2 The impact of fees and expenses 3 Impact of taxes 5 Tax-efficient investing 6 Conclusion: Ongoing attention needed to maintain efficiency In assessing investments, always remember that it is not what you earn, but what you keep, that counts. It does not matter how high the relative performance of an investment is; you still need to pay close attention to taxes and expenses, which can take a large bite out of net returns. This is particularly true for long-term investors who may be less than optimally efficient in terms of taxes and investment expenses. Just as time compounds positive returns, any gap in returns through tax-inefficient or cost-inefficient investing may be magnified more and more the longer one is invested. Exchange-traded funds (ETFs) generally are among the most tax-efficient and cost-efficient investments. 1, 2 An ETF is a unique investment tool that combines some of the features of mutual funds with some of the features of individual stocks. Like a mutual fund, an ETF gives investors access to a group of securities through a single transaction. Like a stock, ETF shares are traded on exchanges at market-determined prices. A variety of investment strategies may be considered to maximize tax efficiency and to minimize expenses. The impact of fees and expenses In this world nothing can be said to be certain, except death and taxes. Benjamin Franklin While Ben Franklin certainly was right, his famous quote could have been extended to include investment expenses. However, investors may have some control over their level of investment expenses, as they do to a degree with how much tax they pay. Knowing how to possibly lower expenses and taxes begins with understanding how investors incur expenses and how investments are taxed. However, risks exist beyond our control as investors. We don t know how or whether tax legislation might be altered in the future, for example. Personal income tax rates might be raised or lowered years from now, which would affect our long-term tax strategies. We can only do the best we can with the information we have at the moment, but be ready to conduct ongoing review. 1 Invesco PowerShares Capital Management LLC and Invesco Distributors, Inc. and their affiliates do not provide tax advice. Please note that (i) any discussion of US tax matters contained in this communication cannot be used for the purpose of avoiding tax penalties: (ii) this communication was written to support this promotion or marketing of matters addressed herein; and (iii) you should seek advice on your particular circumstances from an independent tax adviser. 2 Since ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity may increase the cost of ETFs. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE 2

3 To see the impact over time of a difference in annual expenses, consider this illustration from Lipper. FIGURE 1 Growth of $10,000 Source: Lipper Report, Taxes in the Mutual Fund Industry, 2009 $55,000 $50,000 $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 0% Exp Ratio 1% Exp Ratio 2% Exp Ratio 3% Exp Ratio 1 Year 2 Years 3 Years 4 Years 5 Years 6 Years 7 Years 8 Years 9 Years 10 Years Impact of taxes The quest for maximum tax efficiency is made more challenging by the complexity and unpredictability of our tax system. Dividends, which are a distribution of a portion of earnings, are taxable as ordinary income, which is currently at a rate of up to 35%. The highest tax bracket has changed over the years, and it could change again. Meanwhile, qualified dividends are taxed at lower rates. Dividend qualifications for a lower rate are as follows: The dividend must have been paid by an American company or a qualifying foreign company. It must not be on the IRS list of nonqualifying dividends. It must have met the required dividend holding period. Taxpayers in a federal income tax bracket of 25% or higher are subject to a 15% tax rate on qualified dividends. And those who face an ordinary income tax rate of less than 25% may have a 0% tax rate apply to their qualified dividends. 1 Capital gains on assets held for one year or less are considered short-term gains and are taxed at an individual s ordinary tax rate (up to 35%). Long-term gains on assets held for more than a year are taxed at 0% for taxpayers in the 10% and 15% tax brackets, and at 15% for those in the 25%, 28%, 33% and 35% tax brackets. 3 As of 2013, long-term capital gains rates are set to rise to 10% from 0%, and to 20% from 15%. 4 3 While it is not Invesco PowerShares intention, there is no guarantee that the Fund will not distribute capital gains to its shareholders. 4 Source: taxes.about.com, as of July

4 TABLE 1 Tax Bracket Tax Rate Long-Term Capital Gains on Securities (Held for a Year or Longer) Applies to federal income-tax rates through Dec. 31, 2012 Source: taxes.about.com, as of July %, 15% 0% 25%, 28%, 33%, 35% 15% As investment returns and tax rates are both important, we need to consider both in assessing investment strategies. Taxation of investment returns becomes an integral part of deciding whether to invest in a taxable or tax-free bond, for example. Similarly, the tax treatment dividend-yielding bond, real estate investment trusts (REITs) or capital-gain-producing stocks will help dictate which type of asset to place in a taxable or tax-deferred account. 1 (See Asset allocation on page 6.) Complicating matters further, in recent years, a series of major changes were made to the US tax system. Because what may be considered tax-friendly personalincome-tax rates may be changing at some point, it is helpful to invest in a potentially tax-friendly product, such as exchange-traded funds (ETFs), that is not dependent on the latest tax-code updates. 3 We believe this may help to increase the potential of tax-efficient investment returns, regardless of any potential further changes to the tax system. 1 4

5 Tax-efficient investing Avoid unnecessary trading Although it is impossible to eliminate expenses and taxes, one way that investors may try to reduce them is to avoid unnecessary trading. Every trade can potentially add to an investor s or a portfolio s expenses. In addition, more frequent trading could lead to higher taxes. Capital gains on stocks held for a year or less are taxed at ordinary income-tax rates, rather than lower capital-gains-tax rates. ETFs generally stand out as among the most 1, 2, 3 efficient investments in terms of both expenses and taxes. Calculate taxable equivalent yield Being taxed is not always the worst option. Remember to look at the after-tax result. For example, to weigh whether to invest in taxable or tax-free bonds, your tax bracket and tax rate will factor into your decision along with the yields of the taxable and tax-free bonds in question. To compare your taxable and tax-free returns, use the following formula, which will determine your taxable equivalent yield. Assuming a municipal bond offers a 4% tax-free yield and an investor faces a 25% federal tax rate: 4% (1-0.25) = 5.33% This formula enables us to compare taxable and tax-free investments. Someone in the 25% federal tax bracket would need to earn 5.33% on a taxable bond for the after-tax yield to be equivalent to 4%. The information in this communication is not a complete analysis of every material aspect relating to tax-loss harvesting. The benefits of tax-loss harvesting will vary depending on each investor s income-tax situation. ETFs may have additional risks that may not be associated with an investor s original investment. Individuals should consult with an independent advisor. Tax-loss harvesting An important tool in any tax-sensitive investor s workshop is the option to harvest tax losses. In plainer English, this means offsetting capital gains with losses. Let us say you have sold a stock that climbed substantially in value, and you will have capital gains and owe capital gains tax. If you own another stock that has lost value, you could offset the capital gains tax you would owe on Stock A with a capital loss on Stock B. However, when offsetting gains with losses, short-term capital gains and losses should offset one another; then, the same applies to long-term capital gains and losses. After the offset, any remaining shortterm gain would be taxed at the ordinary income-tax rate. Any remaining long-term gain would be taxed at long-term tax rates. Capital losses that exceed capital gains may be applied against your regular income. Any capital losses beyond $3,000 ($1,500 if married filing separately) may be carried over and used in future years. 5

6 Sell high-cost shares first You may avoid or minimize potential capital gains by selecting the most tax-favorable shares of a security to sell. For example, sell the highest-cost shares first in order to lower your capital gains. ETFs generally allow an investor to do this. Unless a mutual fund s objective states that it is managed specifically for tax efficiency, portfolio managers may not always consider shareholders personal tax liabilities when making buy and sell decisions for the fund. However, they do consider the shareholders best interest in managing the fund to meet its stated objective. 1, 3 Asset allocation To benefit the most from one s most tax-efficient investments, it may generally be best to place them in a taxable investment account and to allocate one s least tax-efficient assets in a tax-deferred retirement account, such as a 401(k) or IRA. The more tax-efficient investments have historically included tax-exempt municipal bonds, stocks, stock mutual funds and ETFs, which typically generate long-term capital gains predominantly. The less tax-efficient holdings have historically included taxable bonds, TIPS and REITs, all of which issue dividends. One reason to allocate assets this way is that the proceeds from traditional IRAs and 401(k)s will be taxed as ordinary income when withdrawn, potentially at lower tax rates than capital gains. 1, 2 Conclusion: Ongoing attention needed to maintain efficiency Maximizing one s tax and cost efficiency involves a lot of detail and numerous strategies. It is always vital to look at net after-tax returns and to be aware of the big portfolio-wide picture as well as the many little but important details. Through all of this, we believe that ETFs remain an invaluable asset in terms of tax efficiency and cost efficiency. 1, 2, 3 They are transparent, allowing investors to know at a glance what they own, with no surprises. They also allow a level of individual investor control, more so than mutual funds, especially when an investor is focused on limiting capital gains, for example. Overall, we believe ETFs hold great promise as one of the most accessible and efficient types of investments within a tax-efficient and cost-efficient portfolio. 6

7 About risk There are risks involved with investing in ETFs, including possible loss of money. Index-based ETFs are not actively managed. Actively managed ETFs do not necessarily seek to replicate the performance of a specified index. Both index-based and actively managed ETFs are subject to risks similar to stocks, including those related to short selling and margin maintenance. Ordinary brokerage commissions apply. PowerShares is a registered trademark of Invesco PowerShares Capital Management LLC. Invesco PowerShares Capital Management LLC (Invesco PowerShares) and Invesco Distributors, Inc. are indirect, wholly owned subsidiaries of Invesco Ltd. Invesco Distributors, Inc. is the distributor of the PowerShares Exchange-Traded Fund Trust, the PowerShares Exchange-Traded Fund Trust II, the PowerShares India Exchange-Traded Fund Trust and the PowerShares Actively Managed Exchange- Traded Fund Trust. ALPS Distributors, Inc. is the distributor of PowerShares QQQ. Invesco Distributors, Inc. and ALPS Distributors, Inc. are not affiliated. An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, which contains this and other information about the QQQ, a unit investment trust, please contact your broker, call or visit invescopowershares.com. Please read the prospectus carefully before investing Invesco PowerShares Capital Management LLC P-FTP-WP-2-E 12/12 QQQ /12 x 12/13 invescopowershares.com

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