Nobody likes to pay taxes, especially on investment portfolios aimed for long-term growth. It obviously follows that to the extent tax liability is reduced, after-tax returns are increased. Tax management does not imply avoiding tax completely but seeks to maximize after-tax returns while maintaining a client’s desired asset class exposure.
We use a comprehensive tax management approach in managing portfolios to help minimize tax exposure for our investors. We are committed to our objective of bringing tax benefits to our clients with minimal or no reduction in pre-tax portfolio returns. Here are the elements of our tax-management strategy:
Asset Location
- The tax status of accounts is considered when choosing where to hold securities. A higher proportion of income-generating securities can be held in tax-deferred accounts (such as IRAs or pension accounts), while a greater percentage of asset classes that generate larger capital gains may be located in taxable accounts.
Tax-Efficient Rebalancing
- Combining accounts of differing tax status in one portfolio can result in more tax-efficient rebalancing than if the accounts are managed as stand-alone portfolios. For example, if an IRA account and revocable living trust account are aggregated together in one portfolio, we could buy and sell securities inside the IRA to rebalance the portfolio, resulting in no capital gain recognition for the investor.
Tax-Managed Mutual Funds
- In certain asset classes, we can use tax-managed mutual funds to help reduce dividend and capital gain distributions that are paid to fund shareholders through the mutual funds. These funds use tax-management strategies performed by the fund manager. Dimensional Fund Advisors, for example, uses proprietary strategies designed by their team of academic researchers to try and minimize or eliminate short-term gains, harvest capital losses when possible, and minimize dividend yield when appropriate.
Cost Basis Evaluation and Reporting
- We track the cost basis of managed assets in taxable accounts and consider capital gains implications when trading and managing taxable portfolios.
- We provide clients with a year-end tax report showing the cost basis of securities sold during the year. We use the “highest cost” method of determining cost to help defer capital gains to future years.
Tax-Loss Harvesting
- We seek opportunities to generate tax losses for clients who would benefit from them. One way to add value to a portfolio in a market decline is to harvest losses while maintaining the portfolio’s proper asset class exposure. This requires careful trading and planning to make sure that tax rules are followed correctly.
