Investors are often concerned about minimizing transaction costs that can eat into their gains, without realizing that taxes can take an even bigger bite out of returns.
Tax-aware investment management offers some protection. This is an active investment approach that aims to maximize after-tax returns. It relies on careful construction of a portfolio and proactive management to strategically capture losses and use them to offset taxable gains.
Sometimes, financial advisors don’t have the deep expertise in the intricacies of the tax code to help minimize taxes and maximize after-tax returns. And sometimes tax advisors work separately, rather than in concert with financial advisors. But taxes can be viewed as a risk, so we bring both sets of expertise to the table to manage your returns and minimize the tax impact.
Tax-aware investing is largely about timing; the idea is to delay gains and the tax liability that comes with them into the future, while maximizing losses that can offset taxes due on gains.
Tax loss harvesting—selling an asset and claiming the loss to balance out taxable gains elsewhere in the portfolio—is a key strategy. Many investment managers will deploy tax loss harvesting only at the end of the year when the burden of taxable gains becomes apparent. Tax-aware managers will do this year-round, remaining alert to opportunities to capture losses.
This strategy turns the risk of loss into a tax benefit. What’s more, funds from shares sold at a loss can be reinvested in a similar asset, balancing or improving the risk profile of the whole portfolio. A tax-aware manager will make sure the new asset is not so similar that the purchase runs afoul of the wash-sale rule.
Strategically timing sales to harvest losses requires flexibility, so tax-aware investment managers will structure portfolios using separately managed accounts (SMAs). These accounts offer individualized, customized management and direct ownership of individual stocks.
Owning assets in an SMA offers an advantage over mutual funds: the tax liability on gains that investors incur whenever mutual funds need to sell shares. Even if you bought into the fund late in the year, you’re charged the taxes for a full year of gains. This cuts into your after-tax investment returns.
More broadly, tax-aware investing will strategically allocate stocks and assets across taxable and tax-deferred accounts. Knowing where to put assets, and which to draw from and when, can have a significant effect on tax liability.
Moving or significantly refocusing your portfolio can also have major tax implications many investors will be unaware of. It’s important to make such transitions slowly in order to minimize a potentially hefty tax hit.
All these tax-aware strategies can help ensure that over time, you pay lower taxes and see a higher net return, without increasing your investment risk. Contact us to discuss how tax-aware investing can help you optimize your returns.
-Toni L. Shears
A quick guide to tax-aware investment management, Alex Papageorgis, Ethic.com, Dec. 8, 2020. https://ethic.investments/insights/a-quick-guide-to-tax-aware-investment-management
Are Your Clients Benefiting From Tax-Aware Investment Management? Stephen Riley and Richard Furmanski, Sept. 10, 2015, https://www.thetaxadviser.com/newsletters/2015/sep/tax-aware-investment-management.html.
Meet the Expert: Nathan Sosner on Tax-Aware Investing, Nov. 2019, AQR, https://www.aqr.com/Insights/Research/Interviews/Meet-the-Expert-Tax-Aware-Investing-Nathan-Sosner
We are Arbor Wealth Management, a Phoenix-based firm that offers comprehensive financial planning services. We’re partners in your financial future. Like a conductor coordinating a beautiful symphony, we’re intimately involved in your financial future. We take the time to know how each instrument in your personal orchestra is performing, keeping all aspects of your plan in tune. We accomplish this by making sure your finances remain pliable, whether you are in an accumulation or distribution stage in life.
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