MONTREAL - Many investment experts believe that taxes, and not trading commissions or management expense ratios, are perhaps the biggest expense many investors with taxable (non-RRSP) investment portfolios may face.

Professionally managed investment products such as mutual funds, brokerage wrap accounts, and investment counsellor pools typically have very high levels of turnover (the buying and selling of securities). High levels of turnover will lead to highly inefficient taxable portfolios, and in turn result in lower after-tax returns.

According to conclusions reached in U.S. and Canadian studies on taxable investment portfolio management, managing taxable investment dollars through "buy and hold" indexed investment vehicles is an exceptionally difficult long-term strategy for active managers to beat on an after-tax basis.

Most investment management reporting in Canada and the United States is done using before-tax returns, but this may change.

The Securities & Exchange Commission is reviewing a proposal to have all U.S. mutual funds disclose both before-tax and after-tax returns in their annual reports, as well as their advertising and sales literature. This event could single-handedly change the light in which U.S. investors view their taxable investments.

If the SEC and U.S. investors take this notion of after-tax returns and tax-efficient investing seriously, Canadians should do the same. Personal tax rates are significantly higher in Canada than in the U.S., so tax-efficient investing should be even more important to Canadians.

At first, tax-efficient investing may not be an easy concept to understand, but once an investor grasps the key issues, there is no turning back.

The following program should help Canadian investors better understand the issues at hand, and empower them to manage their taxable portfolios more effectively.

- Recognize how the tax bills are generated in managed money.

Taxes come from realized capital gains. Therefore, it is the turnover of securities in investment pools that triggers capital gains, and in turn creates an immediate tax bill. Generally speaking, the higher the turnover the higher the tax bill.

- Understand the concept of tax deferral. By now most Canadians understand the power of the RRSP: continual compounding of returns on a tax-sheltered investment structure. Over time, portfolios with very low turnover (5% annual turnover) can generate significant unrealized capital gains versus portfolios with high (80%) or even moderate turnover portfolios (30%).

According to one study, the average turnover rate for a Canadian investment counsellor is 35%, while the average rate for a Canadian mutual fund is 80%.

Based on these turnover rates, the study concludes that managers of Canadian and U.S. equity funds would have to outperform their respected index benchmarks by a margin ranging from 100 to 300 basis points to produce the same after-tax investment returns as a buy-and-hold index strategy.

- Understand the compounding power of the long-term tax deferral. Holding these taxes effectively creates a long-term, interest-free loan from the government.

Now compare two taxable portfolios. The first has high turnover and, in turn, will never be able to build up any long- term tax deferral. The second has low turnover, with the potential to build extra capital from returns off of what is in effect an interest-free loan.

In both cases you will eventually pay all your taxes, but the portfolio with low turnover can add 1% to 2.0% additional after-tax return over a 10 to 20 years, which can have a significant effect on the growth of your investment portfolio over the long term.

- Use exchange-traded index funds with low turnover to create long-term tax efficient portfolios.

State Street Global Advisors and Barclays Global Investors, two of the largest money managers in the world, have created some of the most tax-efficient long-term buy-and-hold investments. Here are three examples of tax-efficient investment vehicles:

Standard & Poor's 60 units (XIU/TSE), managed by Barclays, expose investors to Canadian large-cap stocks with historical portfolio turnover of 3.01% (since 1998 inception).

Spiders, or Standard & Poor's 500 units (SPY/AMEX), managed by State Street, expose investors to U.S. large-cap stocks with historical portfolio turnover of 4.17% (since 1993 inception).

Dow Jones Global Titans index, to be launched this summer by State Street, will expose investors to the 50 largest global companies in the world with historical portfolio turnover of 4.03% (back-tested since 1993).

Remember, it's not necessarily about having more; it's about being wise with what you have in taxable investments.

Keith Matthews is a fee-based advisor and partner of PWL Capital Inc.