Tax Efficient Investments

THREE EASY STEPS WE USE TO HELP BUILD A TAX-EFFICIENT PORTFOLIO

1. Seek to minimize capital gains distributions

If you’ve ever invested in a mutual fund, you may know that they’re required to distribute at least 95% of their capital gains to investors each year.  You may also know from experience that these gains are not always welcome since they come with a tax liability attached. More often than not these capital gains are not large enough to cause investors to stir.  But every year there are a few funds that pass massive unwanted gains on to investors.If your objective is to minimize your tax bill (hint: it probably should be) you’ll want to know about upcoming distributions at the end of each year, and avoid them when it makes sense.  

All in all, this makes it important to track the upcoming capital gains distributions from funds you own or are considering purchasing.  Since capital gains are typically distributed in December (and sometimes late November), be wary of buying new funds at the end of the year.

2. Harvest losses to offset gains

Monitoring for tax-loss harvesting opportunities is a year-round process for two reasons. First, an investment that shows a loss in April may recover by the end of the year. If the loss is not harvested in April, it may no longer be available in December. Second, even if the loss still exists at year-end, a short-term loss in April may have become long-term by December. (Short-term losses are generally more useful to the taxpayer than long-term losses.)

We will use our professional judgment to set minimum amounts and percentages for losses within each equity and fixed income transaction. These figures will determine when tax-loss harvesting activities are reasonably warranted within your portfolio. The percentage hurdle will be lower for less volatile asset classes such as fixed income, and higher for more volatile asset classes, such as emerging market equities, or commodities.

3. Consider replacing underperforming funds with tax-efficient, low cost ETFs

All else being equal, a dividend-focused ETF or index fund will be more tax-efficient than an actively managed dividend-focused product; that's largely because the index funds and ETFs look better from the standpoint of capital gains distributions. Ideally, however, investors focused on maintaining peak tax efficiency should steer their dividend-focused funds to their tax-sheltered accounts (IRAs, 401(k)s) and stick with plain-vanilla broad-market index funds or ETFs for their taxable accounts.

All else being equal, a dividend-focused ETF or index fund will be more tax-efficient than an actively managed dividend-focused product; that's largely because the index funds and ETFs look better from the standpoint of capital gains distributions. Ideally, however, investors focused on maintaining peak tax efficiency should steer their dividend-focused funds to their tax-sheltered accounts (IRAs, 401(k)s) and stick with plain-vanilla broad-market index funds or ETFs for their taxable accounts.