Given recent market volatility, your clients are likely concerned about their finances and worried about the future. Unfortunately, market behavior is far from within your control. However, this can be an ideal time to demonstrate the value of your advice in helping your clients manage the aspects of their portfolios that are within control. Taxes are often top-of-mind this time of year and can be a great place to start.
A sophisticated portfolio, that can track a benchmark and accommodate a tax management strategy, can add considerable after-tax, annual value for your clients. In fact, our research indicates that the projected value of your tax management advice can be 100 basis points annually.2
There are three approaches you can consider to help protect your clients’ assets with regard to taxes now and throughout the year: passive, reactive, and proactive.
You can set up and execute passive tax-mitigating approaches without ongoing monitoring or retooling, saving considerable time. Building a reasonably tax-efficient portfolio includes careful asset allocation and location, selecting a mix of more tax-efficient investment options (such as Fund Strategist Portfolios (FSP), index funds, and municipal bonds) for taxable accounts and less tax-efficient investments (such as high-yield bonds) for tax-deferred and tax-free accounts.
While this does help with tax efficiency, it doesn’t enable you to take advantage of current market environments, eliminate short-term capital gains, or necessarily meet specific client objectives.
Losses on investments can be disappointing – for both you and your clients. However, they offer an opportunity that your clients may not be aware of: helping to offset taxes from other profitable investments within their portfolios. A reactive strategy of harvesting losses can be employed at year-end, in response to the portfolio’s performance over the course of the year, or in response to turbulent market environments like we’re currently experiencing.
Monitoring market activity and taking action in response to downswings can enable you to capitalize on losses and offset gains. However, tax-loss harvesting is largely market dependent, as there may not be losses available at any given time. Additionally, it can result in unanticipated risks to a portfolio. For example, a new investment could perform worse than the original investment or there may be unintended tax implications.
A comprehensive, client-driven tax overlay service can help support clients who may have specific tax or budgeting requirements. This strategy involves carefully managing a portfolio to help reduce tax exposure, minimize short-term capital gains, and optimize risk in an effort to improve a client’s after-tax returns.
Employing this strategy year-round can help realize losses to offset gains or respond to market conditions on an ongoing basis. For advisors, this can be a great deal of time and effort, particularly because it requires customization for each client and active oversight. However, automated tax overlay services can help reduce the burden.
Those who use the Envestnet platform can subscribe to activate our Tax Overlay Services through Envestnet | PMC. This discretionary, holistic tax management solution can help to mitigate the impact taxes have on a portfolio by:
- Delivering customized tax solutions at the individual client account level.
- Managing the account to replicate, as closely as possible, the client’s selected target allocation and its underlying manager models, while helping to eliminate short-term capital gains and honoring client-specific long-term capital gains constraints.
- Deferring the sale of securities, which otherwise would result in short-term gains, until they reach a favorable long-term gain status.
- Helping to establish a tax budget to control the realization of long-term gains.
As the overlay portfolio manager, we are responsible for coordinating the investment activity within an account, freeing up your time to focus on other important aspects of your client relationships and practice.
When investors emotions are high, they’re more likely to need your guidance and support. Drawing their focus to the things you can control can help show your value and ease their concerns. To learn more about how you can leverage our Tax Overlay Services, contact the Envestnet sales team at 855-769-0806.
1. “Defining Wealth Management,” Spectrem Group, last modified August 2018, https://spectrem.com/Content_Product/-defining-wealth-management.
2. “Capital Sigma: The Advisor Advantage,” InvestPMC.com, last modified in 2019, https://www.investpmc.com/sites/default/files/documents/PMC-CAP-SIGMA.pdf.
The information, analysis and opinions expressed herein are for informational purposes only and do not necessarily reflect the views of Envestnet. These views reflect the judgment of the author as of the date of writing and are subject to change at any time without notice. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.
Neither Envestnet nor its representatives render tax, accounting, or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.