Taxes Are Often the Biggest Cost in Your Portfolio—We Treat Them That Way
Investment fees get a lot of attention. We take several deliberate steps to make sure your portfolio is as tax-efficient as it can be.
Start with tax-efficient vehicles
Investment costs add up and can take a serious bite out of your returns. But it’s often overlooked that taxes can be the biggest cost when investing. Rapid trading, market timing, and a disregard for portfolio structure can result in far higher taxes than necessary.
We start by using highly tax-efficient investment vehicles. For the stock portion of portfolios, we use ETFs. ETFs are less likely to distribute capital gains because of something unique about how they’re structured.
Individual investors buy and sell ETF shares and settle in cash. But larger institutional traders called “authorized participants” often redeem shares in-kind, meaning the ETF sponsor hands them a basket of individual stocks rather than cash. This lets ETF portfolio managers swap out low-cost-basis securities without triggering capital gains, reducing the chance of an unwelcome tax surprise at year-end for remaining shareholders.
Asset location: holding the right investment in the right account
Most clients don’t need more taxable income, but many want the stability that bonds offer in their portfolios. When qualified accounts like IRAs or 401(k) plans are available, we generally prefer to hold bonds there. That shelters the interest income from current taxes and defers it until retirement distributions are required after reaching RMD age, when many clients are retired and in lower tax brackets.
For stocks, we generally prefer taxable brokerage accounts. Stocks held for more than twelve months qualify for the more favorable long-term capital gains tax treatment. For clients who hold stocks for the remainder of their lives, a stepped-up cost basis at death could eliminate capital gains altogether. Holding those same stocks inside a retirement account would convert that favorable treatment into ordinary income. We analyze each portfolio carefully to match asset allocation with asset location, reducing your lifetime tax bill.
Year-round tax-loss harvesting
Tax-loss harvesting means selling investments that have declined in value and immediately repurchasing similar investments while being mindful of the wash sale rule. The portfolio stays fully invested, but you realize a capital loss that can reduce your tax bill now or in the future.
Many advisors look for tax-loss opportunities in December as year-end approaches. By that point, it’s often too late. We look for opportunities throughout the year. A good example: during the COVID downturn in early 2020, stocks lost over 35% of their value between February and March, but by December, the market was in the black. An advisor waiting until December to harvest losses would have missed the entire opportunity. We were harvesting in real time.
The compounding effect of tax efficiency
Tax savings aren’t just a one-time win — they compound. A tax loss harvested today offsets gains that would have reduced the capital available to grow. Asset location that saves you 30 cents on every dollar of bond income adds up materially over decades. The ETF structure that eliminates an annual capital gains distribution doesn’t sound exciting but reinvesting that capital over 20 years makes a real difference.
Tax efficiency isn’t a secondary concern that we address after making the “real” investment decisions. It’s woven into how we build and manage portfolios from the start.
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Frequently Asked Questions
What is the wash-sale rule, and how do you handle it?
The wash-sale rule disallows a tax loss if you repurchase the same or “substantially identical” security within 30 days before or after the sale. We manage this carefully. When we harvest a loss, we immediately replace the sold fund with a similar but distinct fund that maintains the desired exposure without triggering the wash-sale rule.
Does tax-loss harvesting make sense in retirement accounts?
No, tax-loss harvesting only applies in taxable accounts. In IRAs and 401(k)s, gains and losses don’t have direct tax consequences until withdrawal. Our focus for tax efficiency in retirement accounts is on the right asset location and, where applicable, Roth conversion strategies.
Does tax efficiency mean avoiding stocks with dividends?
Not necessarily. Qualified dividends receive favorable tax treatment, so dividend-paying stocks aren’t necessarily a tax problem in taxable accounts. What matters more is the overall structure, the account type in which the investment is held, the turnover within the fund, and whether we’re managing gains actively over time. We look at the full picture.
Disclaimer: Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns.