It’s that time of year when most everyone is breathing a big sigh of relief: tax season is finally over. And no matter how you fared this year, if you’re like most people, you won’t have to think about taxes until next December. The picture is quite different in the world of investment management where, a bit like the sunny beaches of California, there really are no seasons—at least when it comes to taxes.
A huge part of my job as an investment manager is protecting client assets through tax mitigation strategies. Using the combination of asset allocation and tax harvesting, my goal—year round—is to keep your taxes to a minimum and maintain tax-efficient portfolios. Here’s how it works:
Asset Allocation is an ongoing process of balancing risk and reward by apportioning the assets in each portfolio based on the investor’s financial goals, risk tolerance, and time horizon. As a vital process to successful portfolio management, I tackle asset allocation by looking at the unique risk and return of the three main asset classes— equities, fixed-income, and cash and equivalents—and how they “play” together within each portfolio. Balancing assets effectively dictates the growth of your portfolio as well as how your assets are taxed. And because effective asset allocation is determined by your individual requirements, there is no standard solution; every portfolio must be (or at least should be) carefully tailored to take advantage of the opportunities presented by the individual stocks within it, as well as each investor’s specific goals and financial outlook.
Tax Harvesting, or “tax-loss selling,” reaches its peak in the fall when I focus heavily on identifying securities that can be sold at a loss to offset the capital gains tax liability within each portfolio. By limiting the recognition of short-term capital gains, which are taxed at higher federal income tax rates than long-term capital gains, tax harvesting can mitigate current and future taxes, and further diversify your portfolio. For example, an individual’s losses in, say, now-bankrupt Eastman Kodak could be sold to offset his or her gains in Apple. While the transaction may not completely eliminate the capital gains tax liability, it could reduce it significantly.
Of course, there are limitations to these strategies. (Aren’t there always when it comes to taxes?) The tax impact of asset allocation is determined, in part, by the assets held. And tax harvesting is most effective and manageable with individual stocks versus mutual funds. The keys to success are careful analysis of each individual portfolio, a detailed understanding of the individual’s complete financial profile, and detailed forecasting for the market and the tax environment.
How these factors impact each portfolio isn’t always obvious. For instance, as a former Washington chief of staff, I always have my antennae up for happenings inside the Beltway that may affect our portfolios. In 2013, it made more sense not to offset certain taxes due to the pending increase in taxes as a result of Obamacare.
Another factor that can shift tax harvesting strategies is the age of the investor. Because estate tax rules calculate capital gains based on the price of a stock on the date of death, it may make sense for elderly investors to hold on to investments that have substantial unrealized capital gains, as this could save thousands of dollars in taxes and add significantly to the legacy passed on to their heirs.
The tax codes are complex (no one has ever claimed that taxes—and tax mitigation strategies—were simple!). But know that when it comes to your investments, “tax season” is a year-round process, and I’m always working for you to keep the bite of taxes at bay.
Were you hit hard by taxes in 2014? Now is a great time to review your portfolio. Working together, we can identify strategies to help mitigate taxes—not only in 2015, but far into the future of your estate.