Investors and advisors have some strong opinions about the relative merits of active vs passive investing.
For the investment department at Waldron, we can see value in both approaches, depending on a number of factors, but the most important of which are the investor’s goals.
One question I often ask clients is, what’s the difference between Nestle and Hershey’s?
They both produce iconic candies, such as Nestle Crunch and Hershey’s Kisses, respectively, source their ingredients from the same geographical locations and widely sell to the same consumer. The big difference is where they are headquartered, Nestle, in Switzerland, and Hershey’s, in Pennsylvania. Some U.S. investors may feel more comfortable investing in Hershey’s because Hershey’s is a U.S. company, despite the fact that the companies use similar raw materials and sell similar end products. But, by instinctively picking one asset class (domestic equities) over the other (international equities), an investor may be limiting their potential opportunities.
Just under 50% of the world’s publicly traded companies are located outside the United States. And at the time of this writing, the two biggest companies in the world are headquartered in China. I mention this because many investors exhibit a home bias when it comes to constructing their portfolio. People are often more comfortable investing in companies which they’ve read about and heard about in the news for years, but the reality is that such a narrow perspective can cause an investor to become over-weight in domestic positions. Of course, every investor will have their own goals and time horizons, and must act in accordance with their capacity for risk, and really, in whatever manner they are comfortable. I would simply point out that ignoring international equities is not a perspective that will provide the necessary diversification to balance your portfolio, nor will it position you to take advantage of valuation opportunities which may exist.
Historically, domestic and international equity performance leadership ebbs and flows. From the late 1990s through the early 2000s, U.S. equities outperformed international equities, from the early to mid-2000s, international outperformed U.S., since then, U.S. has outperformed international. And this cycling is expected to continue. I am not suggesting that anyone try to time the market, but rather, that they should take a global perspective instead of exclusively focusing on domestic equities.
For a more in depth look at the role international equities can play in your portfolio, see my OnePaper.
Stocks, bonds, mutual funds, exchange traded funds, separate accounts, private equity or hedge funds? Active or passive? Fees or commissions? Sifting through all the information in the marketplace, and determining how best to support your investment goals can be extremely complicated.
As a result, for many individuals of wealth, retaining the services of a financial advisor makes sense. Of course, when an individual decides to seek outside support to manage their investments, they will face an abundance of choices among firms, services, and advisor compensation structures as well.
There are many aspects of service to consider when selecting an investment manager, but in our experience, we have found these components to be the most important: a goal-based investment management process; independent and unbiased counsel; and an experienced, accessible team. A critical component of the support you receive from your investment-management team is their process. The investment manager should have an established, methodical process in place to provide continual, goal-based support for the client. For example, at Waldron, our process is to first, take the time to understand your investment objectives and the level of risk you are comfortable with. Second, we learn your cash flow needs and time horizon, and incorporate that information into your long-term strategic allocation. Then, once we’ve constructed your portfolio, our team monitors and makes tactical adjustments to the allocation as needed, to ensure that your established goals are being supported.
Another key to goal-based investment management is independent and unbiased counsel. A simple way to determine if a potential advisor is independent, is to ask if they are a fiduciary. Fiduciaries are unencumbered by conflicts of interest, and operate exclusively in support of the client’s goals. Your investment manager should act as such, and design your portfolio (or portfolios) specifically to meet your goals and financial needs, without any other influences impacting the portfolio design. Whether the task is asset allocation or an implementation decision, an independent investment advisor will have a full range of options at his or her disposal, and will be unencumbered by conflicts of interest when they evaluate them. Conversely, an investment manager working for an institution that offers proprietary investment vehicles may be motivated by incentives to steer clients towards their own, more profitable products.
Of equal importance is the investment management team that will be serving you. At Waldron, we create a customized team for each client, including a wealth counselor, an investment manager and a wealth planner, with each team member selected specifically for having the experience and skillset best suited to serve that client’s unique needs. We also maintain a client-to-staff ratio no higher than 5:1, so that we can provide concierge, high-touch service to every client we work with. In short, when hiring an investment manager, you should be confident that they will be actively supporting your goals, and that your experienced, dedicated team will be accessible when you need them.
Many investors don’t consider taxes when they are constructing their portfolios, but they can be one of the biggest drags on investment returns.
Actively monitoring your investment portfolio throughout the year will help you place assets in the optimal location, harvest any losses to create additional tax assets and maximize returns on fund distributions. A sound understanding of these three practices will assist you in maximizing the after-tax return of your portfolio.
High net worth individuals face heavier taxes on both income and capital gains – therefore, they can benefit even more from pursuing a tax-efficient investment strategy. It is vital that these investors understand how each investment is taxed so they can place their assets in the most tax-efficient entity. Higher turnover asset classes, like small cap equities and other actively traded stocks, should be placed in a tax-deferred tool such as an IRA or 401(k). It may also be a good idea to place corporate bonds in a tax-deferred account. This way, the interest income will not be subject to federal income taxes.
On the other hand, investment vehicles such as stock index funds and municipal bonds can be placed in taxable investment accounts, as you are not assessed capital gains taxes for these investments until you sell them. If you have a large taxable portfolio and are in a high income tax bracket, you should consider investing in municipal bonds for fixed income to maximize what you take home.
Furthermore, if you have a trust, it is very important that you understand who is paying taxes on it. Trusts vary in complexity, and the grantor (who set up the trust) or the trust itself could be responsible for paying the income tax, and the portfolio should be invested with these different aspects in mind.
Certain investment vehicles and entities may not be relevant to every investor, but it is beneficial to understand the options that are available in the marketplace, and how they might fit into your scenario.
No matter what your scenario, it is highly likely that certain assets may accrue losses in a given year. If you sell an asset at a loss and buy something else, you can use that loss to offset future capital gains taxes. The practice of harvesting your losses can reduce your taxable income by thousands of dollars each year. Although most people view tax loss harvesting exclusively as an end-of-year activity, looking at your portfolio frequently may help you identify losses that might no longer exist at the end of the year. For example, if the S&P 500 dips mid-year, this may present an opportunity to harvest investments tied to S&P 500 performance. If the market recovers by year-end, that opportunity could be lost.
Remember that as long as you still have money in an account, a rise in tax rates will likely increase your benefit from tax loss harvesting. This is especially true if short-term capital gains rates rise. Carrying forward benefits of your tax loss harvesting also becomes more valuable in an increasing tax environment.
Distributions of earnings from mutual funds are typically passed on to shareholders at the end of each year, and it is up to you to report any mutual fund transactions on your tax return. If you bought or sold shares in mutual funds frequently throughout the year, you may be paying a considerable amount of taxes. You also need to pay taxes on any gains and dividends. Knowing when a mutual fund plans to make its distributions can help you determine the right time of year to buy or sell it, if you choose to do so. Strategically buying or selling funds before a certain date can help you maximize the after-tax return of your distribution.
A key element of our investment management offering is understanding the far-reaching effects of taxes on portfolios. Click here to learn how investment management is integrated into our comprehensive wealth management approach.
