Featured entries from our Journal

Details Are Part of Our Difference

Embracing the Evidence at Anheuser-Busch – Mid 1980s

529 Best Practices

David Booth on How to Choose an Advisor

The One Minute Audio Clip You Need to Hear

Tag: take the long view

Picking Up Pennies – Volume 6

Welcome to the sixth installment of Picking Up Pennies. Last month, we discussed reducing how often we trade by constructing holistic portfolios with fewer funds and not auto-reinvesting the dividends from those funds. We want to control trading and use the dividends to rebalance the portfolio as needed. Reducing trading reduces trading costs and taxes owed. Although trading often realizes taxes, there are methods of reducing taxes when you trade. This month, we will discuss how we minimize taxes when we trade and why we sometimes trade intentionally to reduce your tax burden.

  •   Volume 1 – Keep Cash Balances Low (Better Chance for Higher Returns)
  •   Volume 2 – Asset Location (Reduces Taxes)
  •   Volume 3 – Using ETFs  (Reduces Taxes)
  •   Volume 4 – Trading ETFs in Competition (Reduces Trading Costs)
  •   Volume 5 – Number of Funds and Not Auto-Reinvesting Dividends (Reduces Trading Costs)
  •   Volume 6 – Tax Lots and Tax Loss Harvesting (Reduces Taxes)
  •   Volume 7 – Summary (Total Impact)

Tax Lots

Whenever you sell an investment, you hold the power to decide which “tax lot” to sell. A tax lot refers to a specific security purchase at a particular price and time. If you bought one share of Apple stock yearly for ten years, you would have ten different tax lots for Apple. One lot for each time you bought Apple. Each year, when you buy Apple, you buy the stock at a different price. This means that the gain and subsequent tax bill for each share of Apple will be different. When you sell one of those ten shares of Apple you own, you have the authority to decide which share of Apple to sell, as each one has a different tax consequence.

The default at most custodians/investment platforms is First-in-First-out (FIFO). When you sell one share, they assume you will want to sell the oldest share you bought. Often, this is not a tax-optimal strategy. Instead, the optimal approach is to choose the share with the lowest tax burden.

Figuring out which lot has the lowest tax burden is not always straightforward. You need to factor in things like wash sales and long vs short-term capital gain treatment. While we will not dive deep into capital gain tax law in this post,  rest assured, whenever we trade, we analyze the tax burden of every lot across every investment you have to minimize the tax impact to you. This allows you to keep more of your invested money and earn a higher after-tax return.

Tax Loss Harvesting

Another key advantage of focusing on individual tax lots is that it allows us to implement tax loss harvesting effectively. Tax loss harvesting involves strategically selling investments that have experienced losses. Since trading is costly, we are generally not searching for trades to place daily. We believe in taking the long view and holding diversified low-cost investments. However, every day, we look at every tax lot in your portfolio for opportunities to harvest losses. By selling individual tax lots at a loss, we can create and bank a tax asset for you: a tax loss. These losses can offset gains from other trades, allow us to rebalance the portfolio without a tax hit, or offset up to $3,000 of income each year. This strategy allows us to reduce your tax bill and realign your portfolio toward your long-term investment objectives.

Whenever we sell a position for tax loss harvesting, we immediately buy a different approved investment to ensure that you remain fully invested as your Investment Policy Statement would direct. We don’t want you to miss out on market returns to realize a tax loss. Most of the time, we will buy a security with a similar exposure to what we just sold to avoid “wash sale” rules, which, if violated, would negate the benefit of creating the loss in the first place. However, that is not always the case. We don’t want a blind tax loss harvesting strategy that does the same thing for everyone. We want to buy whatever asset class is the most underweight. Thus, each client and their situation will be treated uniquely based on their circumstances.

 We optimize our trading based on prior considerations and consultation with each client’s tax advisor so that we know and understand the parameters we should trade in. Further, by leveraging the insights gained from examining individual tax lots and implementing tax loss harvesting, investors can navigate the complexities of the tax landscape while maximizing their after-tax investment returns. We’re committed to treating each client uniquely and executing this strategy daily to pick up as many pennies as possible for our clients.

 

This information is educational and does not intend to make an offer for the sale of any specific securities, investments, or strategies.  Investments involve risk and, past performance is not indicative of future performance. Return will be reduced by advisory fees and any other expenses incurred in the management of a client’s account. Consult with a qualified financial adviser before implementing any investment strategy.

Waiting Patiently in 2023

Clients and long-time followers already know one year of performance is really a nano-second of investing time. However, it’s instructive to look back on 2023 to see what happened in that snapshot of time. The US stock market was up 26.1%1 for the year. Not bad. If you invested $1,000,000 in the US market on January 1st, 2023, fell asleep, and woke up on January 1st, 2024, your account would have a value of $1,261,000. This would have been quite a pleasant surprise to wake up to. However, if you checked your account every month, your experience (mental and financial) was very different. Your portfolio would have lost value in February, August, September, and October. One-third of the months, you would have been frustrated with the returns. From August through October, your portfolio would been down 9.1%! Seeing $1,000,000 fall to $909,000 in a short three-month period may have freaked you out. In October, we got a few calls from newer clients worried about the market and wondering if we should take action.

Then November and December happened. The market ended up returning 15.2% over those two months. 58% of the gain for the year occurred in November and December. If you had sold after the 9.1% market decline, you would have missed over half the entire market premium for the year. Bouncing in and out of the market is a loser’s game. Let me repeat: bouncing in and out of the market is a loser’s game. Staying committed to the long view is a winning strategy over time.

The market behaves unpredictably every year, but two things remain true. First, markets are volatile and can go up and down very quickly. Second, investors are compensated with higher returns by staying invested in the market and observing the risk of volatile equity markets.

Keep in mind that even a one-year time frame is a short period. Equity markets can underperform short-term government bonds for over a decade. Taking the long view means not just staying invested for months or even years, but throughout an investment lifetime.

 

1CRSP US Total Stock Market

This information is educational and does not intend to make an offer for the sale of any specific securities, investments, or strategies.  Investments involve risk and, past performance is not indicative of future performance. Return will be reduced by advisory fees and any other expenses incurred in the management of a client’s account. Consult with a qualified financial adviser before implementing any investment strategy

Swifty vs. Sethy

The charismatic character in the photo above is a marketing genius and a provocative thinker. His name is Seth Godin. Long-time friends know that I’m a Seth Godin Superfan. Call me a “Sethy.” Much of his writing reflects his strong belief in taking the long view.

Seth often says, “People like us do things like this” when fellow tribe members connect their values with how they live their lives. In particular, Seth sounds like us…clients, team members, and other evidence-based investors in this recent post. See if you agree.

If you don’t quite get the connection and want to learn more, let’s talk! Set up a call or meeting here. 

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Featured entries from our Journal

Details Are Part of Our Difference

Embracing the Evidence at Anheuser-Busch – Mid 1980s

529 Best Practices

David Booth on How to Choose an Advisor

The One Minute Audio Clip You Need to Hear

Hill Investment Group