Just as it did during the Great Recession, the time and effort taken to collaborate with our clients to create a proper comprehensive financial plan is proving its worth. Good planning results in an understanding by clients of why they need to do what they need to do with their money. They aren’t invested just for fun. They have goals and the portfolio structure should support those goals. It is far easier to get clients back in touch with their rational side when the portfolio design, implementation and management align with the financial plan and are memorialized in an investment policy statement. The client and their planner have a written record, created under less stressful conditions, of what they decided they would do when the bear growled.
Planning shows its worth in other realms too, especially tax planning. During bear markets, tax-loss harvesting gets a lot of attention. Rightly so, but clients shouldn’t do these things just because their equity holdings are down. They should consider the long-run ramifications.
Loss harvesting makes the most sense when the losses can offset high tax rates. It is not good for everyone. It is over-promoted so frequently, I included it in a previous column of “overhyped strategies.” I can almost guarantee that in the coming months, we will see prospective clients with loss-harvesting trades even though their incomes are low enough to pay a tax rate of zero on gains. This happens a lot with management that relies too much on automation. Many of them will literally get no benefit from losses. We will also see many who used losses to offset ordinary income at 12% without considering the future ramifications.
Good planning dictates we consider not just the effect on this year’s taxes but future years as well. A loss harvest that saves $360 this year (12% ordinary rate X $3,000 max loss against income) is lovely, but if income is expected to increase, they might want to pass on the $360 and keep the higher basis of the position they were going to use for loss harvesting. In fact, if they do have positions showing unrealized gains now, gain harvesting at the zero percent rate might make more sense than loss harvesting.
In this Coronacrash, the high volatility makes being out of a holding or doubling up on one for 31 days to avoid wash sale issues tricky. One risks a spike in price that can significantly offset the value of the tax loss. Swapping to a similar holding immediately seems more popular. Swapping, however, doesn’t get around the issue of basis reset.
Loss harvesting is an important short-term tactic, but it must be considered as part of a long-term strategic plan. Taking losses now means bigger gains later. In general, the higher the current bracket relative to the anticipated future bracket, the more likely the tax-loss-harvesting tactic will pay off.
On the practice management side, my inbox and social media feeds are full of pleas to ramp up marketing and offers from consultants to help me do just that. Most of them say these unprecedented times present the best opportunity to pick up new clients in a long time and that other advisors they have helped are bringing in new clients in droves.
In past declines I got similar messages, though through different formats. It is true that these are unprecedented times. I think the criticism that many advisors are not good marketers and would benefit from professional help is also true. Nonetheless, I am not buying the pitch. I’m sure there are some advisors that are bringing in more new business than usual and that some of these marketing firms are helping make that happen. I’m happy for all of them, but I suspect those advisors are the exception not the rule.
I know a lot of financial advisors. Whether they use marketing firms or not, the majority of them describe the current environment for new client acquisition as slow. This has happened in every big decline I’ve experienced as well. If the pattern holds, growth will ramp up as people realize the light at the end of the tunnel is an exit. Right now, many fear it is a train.
I think there are a few reasons for the slowdown. First and foremost, most people experienced a sense of shock at how quickly the world shut down and how fast the markets dove. It is a normal reaction to be cautious in such times. Scary times make moving seem riskier.