III. Location, Location, Location
Few would argue that location is an important consideration when analyzing real estate. Likewise, thoughtfully assigning assets a specific account location based upon the tax implications of each specific client is one of the more valuable planning considerations an investment advisor can provide. Many advisors handle all client accounts—deferred or taxable—alike regardless of the tax implications. This lack of asset location planning (especially as it impacts the realization of gains in taxable accounts) can be extremely costly. Robo algorithms are ill equipped to provide the sound asset location management advice that many sophisticated advisors routinely provide.
IV. An After-Tax Approach Using Disciplined Gain/Loss Budgeting
The primary objective of high-net-worth investment management should be to achieve the best possible market returns for a given level of risk while actively postponing the realization of taxable gains and maximizing realized losses (especially the short term variety). Without the security specific granularity provided by SMAs, tax-aware investment management is not possible. With the help of tax counsel, advisors can establish an annual tax budget for each client and thereby better plan necessary transactions while avoiding ugly year-end tax surprises. Taxes alone should never drive important investment decisions, but they ought to be a meaningful part of all planning. Extending holding periods, minimizing portfolio turnover and employing HIFO tax-lot accounting can support a much improved after-tax outcome. Robo and hybrid robo-advisors typically use low-cost ETFs which may be tax-efficient (passively postpone taxes) but are not tax-aware (actively minimizing taxes).
V. Ongoing Tax-Loss Harvesting
Tax loss harvesting, the concept of selling securities that fall below their original purchase price or basis, can add extraordinary value to a client’s after-tax spending capacity. Losses can be harvested on an ongoing basis (not just the once-a-year routine reluctantly offered by most SMA managers) as a way of adding value through lowered taxes. As short term gains are taxed at a higher federal rate (39.6 percent) than long-term gains (23.8 percent), seasoned advisors prioritize their harvesting efforts on positions held for less than one year. We recommend loss harvesting of individual securities within a core SMA with suitable quality replacement of the issues sold. With robo or hybrid robo-advisory portfolios, loss harvesting typically requires liquidating a key ETF holding where underlying securities are at both gains and losses. The benefits of this sort of wholesale liquidation are very likely to be lost and the transaction may alter the intended long-term asset allocation.
The Real Threat Is Commoditized Investment Advice
We are convinced that HNW investors, especially the boomers, will continue to favor knowledgeable, well-trained professionals. Those who are willing to take the time to understand the unique financial objectives and constraints of each client as a way of customizing the right balance of proven practices, tools and systems will ultimately prove the most successful. Investment advice commoditization exists where advisors have gotten away from best practices. In an effort to achieve greater scale, many advisors have developed an over-reliance on automated systems and a one size fits all mentality lacking in collaboration, thoughtful examination or tax-aware best practices. One size cannot and should not fit all.
Professional investment advisory success should not be defined by achieving short-term superior returns at the cost of diversification or other ill-defined risks. Nor should it be defined by temporary out-performance to a benchmark of questionable application. Successful advisory must solve the financial problems that keep clients awake at night. Not only do those problems vary by client, they also have a habit of changing over time. Whether the goal is sustaining a retiree’s lifestyle, supporting the education of family members, funding adequate insurance and healthcare, charitable gifting or all of the above, each solution must be customized by making the best use of available client resources.