These 7 concepts are applied to our client's accounts. Please review to gain an understanding of their importance.
Every time an investment is made, there are actually three decisions taking place:
Stocks, bonds, real estate, commodities, etc.
Brokerage account, separately managed account, mutual fund, exchange-traded fund (ETF), closed-end fund, hedge fund, private equity, etc.
401(k), IRA, Joint, Revocable Trust, Marital Trust, Charitable Foundation, etc.
It’s a unique skill to be able to identify which type of investment should go in which vehicle and title. The effect of that decision can alter the taxation, the costs, and ultimately the performance of the investment made. Technically, this is called asset location, and it’s a key driver in the health of your wealth.
For many, it’s easy to understand how taxes can have a large impact on how much money is made in an investment. It’s more difficult to actively manage investments while identifying the tax ramifications of your decisions. As a formerly practicing CPA, Noah Rubin draws on his unique experience on a daily basis. A few of his techniques include:
- Tax-free income vehicles for taxable accounts, such as joint, individual, and revocable trusts
- Higher taxable income vehicles in tax-deferred accounts, such as IRAs, 401(k)s, and foundations
- Continually harvesting tax losses to offset capital gains; even in years when the markets are prosperous, there is still usually volatility throughout the year, providing opportunity to take capital losses, with the intention of ending the year positive in performance, but having a loss for tax purposes
- Deciding whether to distribute gains from a trust or keep them in the trust based on tax ramifications
- Understanding which vehicles are least tax-efficient to avoid unnecessary taxable distributions
- Moving IRA-required distributions directly to a charity to offset ordinary income
Profit-seeking is a priority. Down markets and recessions are a reality. Long-term performance is often achieved by proper decision-making during down markets. Accepting a fair and reasonable return is the healthy perspective. Chasing performance in good times, or selling out of investments in bad times, leads to potential long-term issues.
In the work we do with you, our role is wealth management, not wealth creation. Clients come to us with principal accumulated from their business, savings, inheritance, marriage, and more. It’s our responsibility to manage and grow the money with the intention of providing a fair and reasonable return based on economic realities. Practical examples of this thinking include:
- Compounding income
- Asset location
- Control what you can
There are many layers of potential fees, costs, and charges associated with your investments, and in our opinion, sometimes it’s worth paying a “high fee” to gain access to a unique strategy. Generally, with the majority of strategies used, paying more doesn’t mean better performance. Therefore, our investment decisions are made with a bias toward frugality and helping you pay as little as possible.
The most obvious method for potential long-term growth is to own a majority of equities in your portfolio. Not everyone is comfortable with the risk tolerance needed to achieve this, but we believe that is often due to the power of compounding interest being overlooked. Earning stock dividends and bond interest – and reinvesting that income – is another method for creating potential long-term growth.
There is an often-told story that when Albert Einstein was asked what mankind’s greatest invention was, he replied, “compound interest.” Equally quotable, Benjamin Franklin described it by saying, “Money makes money. And the money that money makes, makes money.” That is probably the simplest explanation of compound interest you’ll find, and that explanation is why we utilize it.
If you are looking to sell something in your portfolio because you need cash, how do you make that decision? Whatever you choose can play a crucial role in performance and taxation. Do you…
- …sell pro rata across all holdings in the account?
- …sell investments that are trending up to lock-in profits, or do the same for trending-down investments in order to avoid further losses?
- …accept a tax gain, or find an investment that won’t cause gains?
- …take into consideration how the sale affects future income from the portfolio?
- …look at which asset class it should come from and why?
In looking at whether you should invest aggressively or conservatively, there’s a lot to consider, such as the timeframe in which you’ll need money for living expenses or a large purchase. The timing of your cash needs should be a primary driver of risk vs. reward, as well as the aggressive vs. conservative decision about how your money should be invested.
The generic answer is often the younger you are, the more aggressive you should be. And on the other side of the coin, if you’re older, you should be more conservative. To debunk that statement, consider these scenarios:
While she is young, she can’t be too aggressive due to the timing of when she’ll need cash for the purchase.
Well, he has pension income, Social Security, and portfolio income that more than covers his living expenses. He rarely uses his principal, and he could consider having his money invested less conservatively for long-term growth for his children’s benefit.