Strategies allows me to use the model to come up with expected returns on all the asset classes. I assume that the expected return on cash is 2% and that the expected return on the reference portfolio is 6% (a market premium of 4 percentage points). Preliquidation Aftertax Expected Return To form aftertax expected returns, in addition to before-tax expected returns, four additional pieces of information are needed for each asset class: Example of Reverse Optimization Without Taxes Ref Port. (%) Beta Expected Return (%) Standard Deviation (%) 1 US Large-Cap Stocks 15.25 1.30 7.20 15.00 2 US Mid-Cap Stocks 4.36 1.56 8.24 18.13 3 US Small-Cap Stocks 2.18 1.64 8.55 20.39 4 Global DM x US Stocks 19.28 1.65 8.58 17.61 5 Emerging Market Stocks 11.93 1.98 9.92 22.11 6 Global REITs 1.40 1.63 8.51 20.38 7 US Bonds 21.91 0.07 2.30 3.17 8 Muni Bonds 0.00 0.09 N/A N/A 9 Global Bonds x US 23.70 0.44 3.78 7.73 0.00 0.00 2.00 0.39 100.00 1.00 6.00 10.34 Reference Portfolio short-term and long-term capital gains returns. 1 The division of before-tax expected return into EXHIBIT 1 10 Cash qualified and nonqualified income returns. 3 The division of expected capital gains return in 4 Turnover. expected income and capital gains returns. Asset Class 2 The division of expected income return into Source: Morningstar. From these data, we can estimate pre- and post-liquidation expected aftertax returns. Preliquidation returns are estimated under the assumption that unrealized capital gains are not taxed. Postliquidation returns are estimated under the assumption that at a specific day in the future, the cumulative value of the assets invested in an asset class are sold and capital gains are realized and taxed. In the remainder of this section, I discuss how to estimate preliquidation expected aftertax returns. In the next section, I discuss how to use preliquidation returns to estimate postliquidation returns. For the division of before-tax expected return and expected income on each asset class i, let: T Bi where: = qi LTCG + (1 - qi) Ii CGi Pretax Expected Return Income Capital Gains (%) (%) Fraction of Income Qualified (%) Fraction of Capital Gains Long Term (%) ∆t = = LTi LTCG Total (%) 1 US Large-Cap Stocks 7.20 1.81 5.39 55.48 79.35 28.90 2 US Mid-Cap Stocks 8.24 1.96 6.28 87.99 84.90 22.40 + (1 - LTi ) VTi = V0i (1 - 24.13 i = Ai 6.12 CGi 23.02 14.21 (1 - TOi ) Bi 23.97 21.68 74.30 6.75 81.61 6.84 2.32 43.62 7.47 6.56 55.16 8.52 6.01 75.44 6.55 100.00 100.00 1.38 100.00 100.00 1.41 100.00 100.00 2.27 100.00 100.00 1.20 8.55 1.85 6.70 89.17 80.17 22.17 4 Global DM x US Stocks 8.58 2.93 5.65 83.42 53.09 23.32 5 Emerging Market Stocks 9.92 2.69 7.24 84.27 85.33 29.38 = TL ( VTi - V0i ) 23.15 22.93 i 6 Global REITs 8.51 5.23 3.28 52.97 73.31 29.41 7 US Bonds 2.30 2.30 0.00 0.00 0.00 8 Muni Bonds N/A N/A N/A 0.00 0.00 9 Global Bonds x US 3.78 3.78 0.00 0.00 0.00 2.00 2.00 0.00 0.00 0.00 25.34 40.00 V L = 40.00 VTi - TLi Ti 40.00 40.00 1 VTiL T 40.00 L = 40.00 -1 Ai V0i 40.00 40.00 Source: Morningstar. Ei Morningstar Q3 2020 ) 49.95 US Small-Cap Stocks 50 OI 4.20 3 10 Cash OI = (1 - Ii ) IRi + CGi - TOi (1 + CGi - COSTi ) CGI Blended Tax Rate Ai Aftertax On Capital Expected On Income Gains Turnover Cost Basis Return (%) (%) (%) (%) (%) T Asset Class ∑ v= t EXHIBIT 2 Preliquidation Aftertax Expected Returns = IRi + CGi =1- L Ai Bi i LTCG 1 (1+ r )v- t