Tax Efficiencies

A sophisticated financial plan can be derailed by unsophisticated portfolio management—particularly during times of market volatility.

Should markets experience a year of negative returns, you may find yourself fielding some difficult questions from clients about their tax liability as it relates to their mutual funds. 

When investors buy into a mutual fund, they are buying into the cost basis of when the fund bought the security, not when the investor bought the fund. That means they could owe taxes on growth that occurred long before they owned the fund, without ever having participated in its appreciation. 

On the other hand, if their portfolios are comprised of individual stocks and bonds, they own the cost basis of each holding, which offers profound tax benefits. 

Tax Loss Harvesting

When investors own their own cost basis, their advisor or portfolio manager can tax-loss harvest throughout the year. In this scenario, a security that has experienced a loss can be sold and replaced with a similar one to offset taxes on gains. In essence, tax loss harvesting ensures clients stay invested to maintain optimal asset allocation, while also realizing less in capital gains.

Compounding Returns

Less in taxes means more in dollars at work. From 1926 to 2018, the tax-loss-harvesting strategy delivered an average annual alpha of 108 bps over and above a passive buy-and-hold portfolio.* 1.08% after 10 years = 11.34% compounded return. 1.08% after 20 years = 23.97% compounded return.

Charitable Giving

With private accounts of individual holdings, your clients have the option of gifting specific securities to the charities of their choice, tax-free. In other words, rather than selling a security, collecting the gains (to later donate via a cash donation), and paying taxes on those gains, the investor can gift the security directly, without incurring any tax obligation on that security. .

*An Empirical Evaluation of Tax-Loss-Harvesting Alpha” by S.E. Chaudhuri, T.C. Burnham, and A.W. Lo, published in the Third Quarter 2020 Financial Analysts Journal.