Strategies for Keeping More of What's Yours

A successful client of ours recently asked us to summarize the ways in which we keep her taxes to a minimum while managing their investment portfolio.  I responded by discussing a five-pillar foundation for effective tax management.  These include:

  1. Structure – Most of our portfolios are comprised of low-cost exchange-traded funds (ETFs).  Unlike mutual funds, which make taxable capital gains distributions to their investors regardless of the investor’s activity, ETFs only generate taxes through dividends or if an investor decides to sell at a gain.  Bottom line, they are clearly among the most tax-efficient investment vehicles. 
  2. Low turnover – This is perhaps the most impactful strategy, after creating a financial plan.  We don’t create unnecessary short-term gains unless we have a much better idea for where to invest your money. 
  3. Asset location – It is more efficient to own stocks in taxable accounts, so carefully move the bulk of your taxable accounts towards equities over time as you feel secure with your amount of short-term liquidity.  And if you must own bonds in your taxable account, don’t neglect municipal bonds, which are exempt from federal and state taxation.  Real estate investment trusts (REITs) and Treasury Inflation Protected Securities (TIPs) work best in IRAs since they generate income each year that is taxed at ordinary rates.
  4. Tax loss harvesting – Investment losses are inevitable given market volatility, but be smart about turning these into some economic value and don’t sit on your losers forever.  Better yet, don’t own too many individual names and you’ll have far fewer losers.  And always match short term losses with short term gains, not long-term gains. 
  5. Diversify – When some asset classes zig, others zag.  By using ETFs, it’s easy to change exposure and gain access to risk factors that have been rewarded over time, including value and small cap stocks, which can be held for maximum appreciation without needing to create turnover that creates capital gains.

Tax efficiency is just one way we as advisors provide value to our clients.  The other primary sources include asset allocation, withdrawal strategy, product due diligence, and most importantly – goals based advice.  More on this last point in a future blog!

David WebbMike Giefer