Investment and Asset Management
An important consideration when structuring your portfolio
2021 was an exceptional year for the stock market. Even if your investments performed admirably, however, your returns may be eroded by as much as 23.8% for long-term capital gains and 35% for short-term gains realized on positions you sold within a year after purchase. Taxes, of course, are inevitable, but that doesn’t mean you have to pay more than your fair share. The chart below offers some ideas for structuring your portfolio to minimize, or a least reduce, the deleterious effect of taxes on your investment returns.
Returns on these accounts are fully taxable when you realize them. The problem is that you may be realizing returns without realizing it. Ordinarily, you realize a return when you sell an investment, but if you participate in mutual funds, hedge funds, or separately managed accounts managed by professional asset managers, you may be generating capital gains on positions sold within the investment.
Some managers trade more frequently than others in an effort to enhance portfolio performance. In their quest for returns, they often fail to consider taxes. Portfolio turnover can be high, and short-term capital gains, which are taxed as ordinary income, are often generated in abundance.
Mutual funds may also throw off what is sometimes called “phantom income.” These are distributions of dividends and/or capital gains that are reinvested in additional fund shares. You never really see them, but you’re taxed on them anyway. In fact, many investors find themselves paying taxes on capital gains distributions even while their fund shares have declined in value for the year.
Information on turnover and capital gains distributions is readily available to investors who are willing to look for it. In addition, some managers pay close attention to taxes and employ techniques like Tax-Loss Harvesting to offset gains for tax purposes. Your advisor should be able to provide you with recommendations that take your tax situation into account.
Tax-Free and Tax-Deferred Accounts
Turnover and phantom income are not an issue if the investments that generate them are in your IRA, Roth IRA, 401(k), variable annuity, or other tax-advantaged account. Here, you can look for investments that focus on returns without regard for taxes and select those with histories of strong performance without excessive risk.
What you keep is as important as what you make
At Lenox Advisors, we understand the importance of tax-conscious investing. For example, we typically employ a strategy known as Tax-Loss Harvesting for clients with taxable accounts. As its name implies, this strategy involves:
- Identifying losing positions in your portfolio
- Deciding whether to sell those positions and harvest losses
- Using losses to offset gains generated by the sale of other positions
Some financial firms promote year-end tax planning every autumn. With just a few months left in the year, investors can identify positions
with unrealized losses, sell those positions and realize losses that they can use for tax purposes. At Lenox, we manage tax losses on a
year-round basis so we can realize them as needed. By doing so, we can make our investment decisions solely on the basis of whether an
individual investment is a viable candidate for future growth, not on whether selling it would trigger a taxable event. To learn more about
our approach to tax-conscious asset management, please contact Lenox Advisors at any of our offices across the US.