Tax Efficient Investing

Andrea Casaw

April 29, 2015

It’s incredible to be talking about tax problems with portfolios.  For several years, taxes have been a minor concern to most investors due various factors, including low Bush era tax rates and a bear market.  In fact, many investors had plenty of tax losses to carry forward which sheltered them from future gains for several years to come.  But today, we find ourselves several years from the Great Recession of 2008 and those carry forward losses are mostly gone.  The investors who had the guts and foresight to stay invested during the tank of ’08 are now faced with potentially large realized and unrealized gains in their investment portfolios.  This tax season was especially painful with the S&P 500 experiencing back-to back years of impressive returns coupled with the recent higher tax rates.  Federal, state and local taxes are on the rise for many, with the highest tax bracket expecting to pay 39.6% (up from 35%) on net short-term gains and 20% for dividends and long-term cap gains (up from 15%). For those higher incomes, there is an additional punch in the gut of 3.8% on your investment income and 0.8% on your waged income.  With taxes and gains on the rise, taxable investors should reassess their portfolio strategy for this new reality.

So, what can we do to diminish the tax pain while not ruining the capital gains in investment portfolios?  

  1. Tax Loss Harvesting:  While I hear the eye roll from many, harvesting is not merely a way to make your bad investments look useful.  In a diversified portfolio that has securities that own their cost basis (i.e. not mutual funds), there will be securities  that experience times when they’re out of favor.  Systematically throughout the year, a portfolio tax manager can harvest the securities that have losses, and buy them back later once the wash sale rule has expired.  Harvesting done effectively can allow the portfolio to grow, earning unrealized gains and locking in realized losses. 
  2. Smart Investment Product Selection:  You can have all the diversification of a mutual fund without having to incur the fee and tax inefficiencies.  Tax efficient investment vehicles or tax efficient asset managers (separately managed accounts, low turn-over mutual funds, ETFs, etc.) can be used flexibly and offer greater tax efficiency.  We often use the analogy, “Would you rather take the bus or limo in your journey to financial prosperity?”.  The bus is like a high-turnover mutual fund where you’re at the mercy of all the other shareholders of the fund.  If your fellow shareholders decide to sell at a gain, you all share in the gains of the fund, even if you don’t sell.  The limo is like a separately managed account (SMA) where you own the cost basis of the securities is the SMA and are not effected by other investors in the same strategy.  In fact, many institutional portfolio managers manage the same strategy in a mutual fund and a SMA form.  The minimums for the SMAs are higher than the mutual funds, but these minimums have come down the last few years.  
  3. Low Turn-Over Managers:  Some managers will trade many securities monthly, often on a short-term gain basis.  The best investment firms are writing opinion reports on asset managers that not only include their performance and BIOs of their talented teams, but also the turn-over ratio.  Great managers select great securities and hold on to them for a longer period of time.  
  4. Insurance Based Products:  Insurance by law has tax efficiencies that can be beneficial for a portfolio.  We recommend only allocating 10% of an overall portfolio strategy to insurance based products since they tend to  be illiquid and packed with fees.  

 While we say taxes show you’re making money, we know there are ways to diminish the tax burden on your investment gains.  I’d be happy to talk with you about the tax efficient approaches that fit your goals, risk profile, and financial planning needs.  Happy to set up phone time or meeting at Josh Nowack's office.

Andrea Casaw
Wealth Advisor
Morgan Stanley Wealth Management 

800 Newport Center Drive, 5th FL
Newport Beach, CA 92660
o - 949.717.5407
f -  949.717.5333

NMLS #1310685



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