Breadcrumbs

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.

Asset Location 

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.

Tax Loss Harvesting 

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.

Mutual Fund Distributions  

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.

Benjamin M. Greenfeld, CFP®

Partner and Chief Investment Officer

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