Tax Efficient Investment Management
Tax Efficient Investing and Allocation Between Account Types
To make trading and monitoring portfolios easy for them, many financial advisors structure their investments exactly the same way across multiple client accounts.
At WealthArch, we customize client portfolios to not only fit their personal financial circumstances, but also to maximize tax efficient investment management. We take the extra time and effort to do what is best for our clients and not what is easiest for us.
For our clients with multiple account types (retirement and non-retirement specifically), we would allocate a specific investment to the account would stretch their dollars further.
For example, if we were buying a stock with a medium-to-high dividend yield and good prospects for capital appreciation, we would typically purchase this stock in an IRA account, so that they don’t have to pay taxes on the dividend and capital gains tax on the profits (if we choose to sell it).
On the other hand, if we were purchasing a stock that didn’t pay a dividend and had a riskier profile, the stock would typically be purchased in a taxable brokerage account, so they will pay less or no taxes on the dividends and be able to deduct capital losses in case the stock moves down in value.
This sounds simple, but in practice there is much more care and thoughtfulness to the way we do it. Other factors such as the quality of the business and the client time horizon also come into play when we think about optimizing a client’s portfolio.
Tax Loss Harvesting
Another advantage that clients with multiple types of accounts is that it allows us to harvest tax losses in a more efficient way. Tax loss harvesting involves selling certain investments that are below their purchase price in order to offset the taxable gains from the sale of investments that increased in value. For example, if you sold one stock and made $5,000, you would pay taxes on that $5,000 gain. But if you also sold an underperforming stock at a $3,000 loss (in that same calendar year), then you would only pay tax on the gain of $2,000.
The most common way the typical financial advisor or investment firm harvests tax losses is to sell an investment and buy a substitute. We believe that a better way of harvesting tax losses is to sell the investment in a taxable account, but buy the exact same investment in a retirement account. Doing this allows us to capture the tax benefit without the need to buy a less attractive substitute. As such, there is no change to a client’s overall portfolio.
Minimizing Capital Gains Tax
Selling investments should also be done with care. At WealthArch, there are a select few companies we determine to have very favorable long-term compounding potential. Since we are long-term investors, we do not sell these stocks unless something has significantly changed within the company or the industry it is in.
We call this group of stocks our “coffee can bucket”. We metaphorically shove these stocks we purchased at discounted prices in a coffee can, lock it in a vault, and watch it compound over time. Holding these stocks longer allow us to grow our clients’ money with less going to Uncle Sam. While not all our positions are coffee cans, it is our favorite type of investment.
Compounding Tax Advantaged Dollars Even Further
Because every dollar counts, we want our clients with multiple account types (retirement and non-retirement specifically) to minimize withdrawals out of their IRA. We help clients do this in 2 ways.
1) When a client is retired and we are planning how much they are going to withdraw from their retirement accounts, we conduct a comprehensive review of their financial situation. First, we take a look at their previous year’s tax return and ask them how much money they need for the coming years. Then, we would compare that to current Federal and State marginal tax brackets. Finally, based on their full list of investment and bank accounts, we would make recommendations on where to withdraw the money for the coming year with the goal of minimizing taxes not only for the current tax year, but also for future ones as well. In other words, we don’t want our clients to take big chunks of money out of their IRA in early years and try to gradually pace the withdrawals through their lifetimes to maximize tax efficiency.
2) Most firms would charge their investment fees to all their clients’ accounts proportionally. Hypothetically, if the investment fee amounted to $1,000 in the quarter and the client had an equal amount of money in their IRA and taxable accounts, they would charge $500 to their client’s IRA account and $500 to their client’s taxable account. Operationally, this is easier, but this is not tax efficient. For WealthArch, in the same scenario, we would charge the full $1,000 to the client’s taxable account and $0 to the IRA, because we want every single dollar working as hard as possible for our clients.
Conclusion
As you can tell, managing portfolios this way adds a lot more complexity to the process, but we don’t mind, because we manage your money the way we do our own, and we think the extra effort is worth it.
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Earl Yaokasin, CFA, is an investment manager who runs WealthArch Investment Services in Pasadena, CA. He is a fiduciary with over twenty years of experience, and whose entire personal portfolio is managed by the firm in the same investments as the company’s clients. His firm focuses on value investing, similar to Warren Buffet’s successful approach, and disciplined strategies designed to create growth with downside protection, enabling clients to move steadily towards their life goals and aspirations with confidence.