So far, 2016 has been eventful for many investors. After more than three years of low volatility across equity markets, we’ve seen a sharp rise in volatility largely driven by declining oil prices, concern around Chinese economic growth and emerging markets as a whole.

On top of that, the U.S. Federal Reserve finally raised interest rates for the first time in almost a decade at the end of 2015. The coverage up to the Fed’s year-end decision drove additional uncertainty, market movements and further speculation about the timing and magnitude of future rate rises in 2016. Through this uncertainty, returns are expected to be somewhat modest over the course of 2016, meaning financial advisors will need to work even harder and consider all possible investment options.

Taken together, these macro events signal a busy year for advisors. With the recent market volatility, many may not have considered a key way to turn market shifts to their clients’ advantage for taxable accounts—tax-loss harvesting. When implemented correctly and in certain situations, declines in client portfolios can be made into tax benefits, allowing advisors the potential opportunity to turn a portfolio decline into improved returns for their clients when taxes are taken into consideration.

Talking About Tax

It may seem counterintuitive that down markets may help improve portfolio returns. However, selling down assets and harvesting the losses for tax purposes can do exactly that by simply diminishing the overall tax burden on the portfolio.

And the opportunity is there. Using the same source and methodology found in the article, “Taxes: What A Drag,” by Russell Investments, the average tax drag on U.S. active and passive equity investments over the past 10 years (ending on Dec. 31, 2015) was 1.23 percent. Over the same period of time, average U.S. equity mutual fund expense ratios were 1.21 percent. Yet, many advisors focus on performance and expense ratios, without giving much thought to taxes when developing their clients’ portfolios. 

While expense ratios are important to consider when evaluating mutual funds, tax drag is a hidden expense ratio which many advisors overlook or may not even consider for their taxable accounts. While 1.23 percent per year may not sound compelling, reducing this expense ratio can have a material impact on an investors’ after-tax wealth. Imagine reducing a 1.23 percent tax drag by 75 bps. Over a 10-year period, the compounding effect represents a cumulative 7.8 percent improvement in after-tax returns—a significant amount many investors may not be considering.

Nevertheless, advisors and their clients are barely discussing taxes. Russell Investments’ Financial Professional Outlook (FPO) survey findings, released in August of 2015, report that while 53 percent of clients saw a larger tax burden in 2014, dialogue about tax strategies decreased. Furthermore, only 22 percent of advisors considered taxes as one of their most common topics of conversation with clients that year. By all appearances, advisors are missing a key opportunity to improve client outcomes.