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Minimize Taxes With Your Investment Plan

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Taxes have a significant impact on the total return of your investments. This is not to say that ANY decision should be based solely on the tax consequences. You must first of course consult with your wealth management advisor to determine the right type of investments for you based on such factors as market conditions, your short and long-term goals, properly diversification of assets across types and industries, dollar cost averaging, risk tolerance, and a number of other factors. Also remember that you are competing for returns with pension portfolio managers that do not necessarily have to address short-term tax issues in determining the returns on their investment portfolio because much of these are already tax advantages because they are working with pre-tax dollars and are tax deferred. So with all else being equal, the major difference between you and institutional pension investors are taxes related to both taxable and tax-deferred investments.

So what does this all mean? For high net worth clients, optimizing their return is much more complex and that they will need to review their portfolios regularly with both their investment advisor and their CPA. This is further complicated by the fact that each portfolio is unique and that sometimes tax strategies may negatively impact short-term investment advice. For this reason, many advisors may not include the CPA in meetings with their clients and that often results in a costly mistake. However, with demanding market conditions and better understanding by the public that they need a team of advisors that work together, many investors are now demanding at least annual review meetings.

The basic idea of tax advantaged investments is to make the most of the after-tax return potential of each portfolio. The objective is to maximize this return in a cost-efficient transparent way as opposed to the traditional methodology of many investment advisors to focus on pretax returns.

First, I will state I am NOT a financial advisor! However, a fairly typical strategy would be to determine a portion of the portfolio that should include a portion attributable to high quality actively managed large cap stocks that have low turnover and may also include money market, mutual funds and other investment vehicles recommended by the wealth manager. Another portion of the portfolio needs to be tax deferred by possibly investing in equities with above average dividend yields and dividend growth. This avoids taxation of dividends and capital gains.

Some specific recommendations to avoid unpleasant year-end tax surprises include:

Budget For Gains– this is no different that when you prepared your initial financial plan but this needs to be done annually to provide your CPA and wealth manager with the maximum amount of net realized gains that is acceptable for the year. Emphasize long-term gains, and portfolio turnover but this much be balanced against the long-term growth of the portfolio. Also, keep in mind that when distributions are taken to consider the effect of gains.

Utilize Tax Loss Harvesting – Utilize losses to offset gains, especially in short-term situations. This is a powerful tool when budgeting for your gains. These losses can offset short-term gains that would traditionally be taxed at higher rates. If done properly, it is a great way to build a reservoir of both short-term and long-term losses that accumulate to be used during market corrections. The strategy requires a focus on positions held for less than one year and the use of highest-in, first-out (HIFO) accounting to postpone or minimize taxes. Remember to consider avoiding wash sales accurate accounting of purchases by lot will be necessary.

Maintain a Long-Term Investment Focus – Buy-and-hold portfolios can avoid portfolio turnover (resulting in gains and fees), avoiding market timing, and missing out on substantial increases. There have been many studies of investors who have missed out on only a few days of gain over a period of years by selling to get out of the market and then getting back in too late after the market had already soared. It is really hard to time the market once. To time it twice is nearly impossible. Also, most investors have forsaken long-term growth for short-term returns and have lost out substantially over the long run due to the difficulty of consistently generating profits and avoiding losses from day trading and focusing only on the near term future. Instead, focusing long-term can diminish distractions from market volatility and other timing problems. Finally, poor market performance may be a result of the investment advisor who actively manages the fund, often underperforms and charges significant fees. A long-term focus avoids this – stay the course!

In summary, investors, especially high-worth investors need to meet with both their tax and investment advisory professionals at least once a year and as often as quarterly to review their investments. There are a number of published articles that show that these regular meeting can add as much as 3% your annual return!

Adopted From Stephen Riley CFA,CFP & Richard Furmanski CFA,CFP 6/2/16 The Tax Advisor


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