The Opportunity At Hand
Market volatility underlines an opportunity advisors may be missing to improve outcomes for their clients. Of course, all investments have a certain amount of natural volatility baked in—whether they’re funds or stocks or anything else. Depending on the level of volatility, advisors can lean into naturally occurring shifts in stock or fund prices in an attempt to create tax benefits. In certain situations, these benefits can then be carried forward and applied against future gains with the goal of improving after-tax returns.
Let’s be clear. The goal is not to avoid any and all taxes. The goal should be working to create higher after-tax wealth. Avoiding taxes is not a financial plan. Managing taxes in a thoughtful, holistic way should be part of a larger portfolio strategy working towards a desired investment outcome.
Beyond potential improved returns, tax-managed investing strategies can be a key point of differentiation for many advisors. Given the recent FPO survey responses, many of their peers may not be paying enough attention to these strategies either.
In sum, holistic tax-management can be a vital part of an advisor’s offering, further improving portfolio performance and client relationships in general.
Key Considerations
It’s no secret that getting clients on board with a strategy which involves selling an investment at a loss can be challenging. The idea that a tax benefit, created by selling at a loss, may carry value for a portfolio is not intuitive for many investors. As a result, advisors need to be sensitive to client concerns, while seeing the opportunity to demonstrate their value and discuss their strategic reasoning behind their decisions.
As always, every individual case is different. This is especially true when it comes to tax-management, as factors including client cost basis, tax bracket and other unique circumstances which may need to be considered to fit the client’s specific situation.
That said, tax-management does not apply to only the super wealthy. Consider a married couple with a taxable income of $74,900. Their marginal tax rate is 25 percent. Think about that! For every incremental dollar of taxable income above $74,000, $0.25 goes to federal taxes. The tax rate can go as high as 43.4 percent for those in the top bracket when you also include the 3.8 percent Net Investment Income Tax many investment earnings receive.
As is often the case, the first step for advisors is creating a dialogue with clients. Russell Investments’ FPO survey, released December of 2015, has found that both investors and advisors are focused on volatility and hold a somewhat pessimistic view of the economy. Yes, it’s vital for advisors to work and address these concerns. But that’s only part of the task.
The next step is to encourage clients to think strategically. Again, volatility can actually play to an advisors’ advantage when discussing tax issues, because the attached opportunity at-hand is to harvest losses. Taking a step back, the key is to create a holistic portfolio and a successful tax-management strategy.