Look For The Loss
Even with a balanced portfolio, it’s prudent to manage capital gains liability over time by offsetting gains and losses where possible. In partnership with a tax professional, advisors and their clients should set an annual budget based on long-term market growth expectations, various estate planning structures or capital losses available outside the investment portfolio. Typically, the 5 percent average annual capital gains budget mentioned above is sufficient to allow for normal portfolio management and rebalancing. Many investors will view the budget as set in stone. But, it’s an advisor’s job to help clients understand the need for flexibility given current market conditions and exposure to risk. In the near-term, advisors can help clients minimize the impact of capital gains by looking for losses elsewhere in the portfolio. Long-term, investors can recover large capital gains in a given year via lower capital gains in other years, such as during the next bear market.
Have The Conversation
Financial advisors should consider the above and plan to structure conversations with clients to clearly explain the risks and overcome the natural hesitation clients may feel at the prospect of increasing their tax exposure:
1. Discuss the current economic climate, market volatility and variability of return.
2. Explain the capital gains tax consequence relative to return projections, agree and adjust capital gains budgets accordingly.
3. Identify ways to offset losses in the immediate investment portfolio and beyond.
Given today’s volatile market environment, advisors and investors should focus on properly balancing portfolios and worry less about a 1 percent tax consequence. It’s most important to maintain an appropriate allocation for the market circumstances we’re currently facing, and not allow capital gains recognition to prevent striking the right portfolio positioning. From my perspective, it’s well worth a few more tax dollars.
Dan LaPlante, CFA, is the chief investment officer for private wealth management at Citizens Bank.