Tax Planning and Investing – Part 1

I want to talk today about tax planning and how it relates to investing. In our financial life, there are really four quadrants. 


Quote About Tax Planning - Bertram FinancialThere is the tax planning quadrant, then we have cash flow, which includes retirement income, investment planning, and then estate preservation. What happens a lot is people will focus on whatever area they’re in, investing for example, but the fact is whatever you do with investments can affect the other areas of your financial life. It can affect your income and it definitely can affect your taxes.


So we should be looking at the big picture, all four of those quadrants need to be coordinated and working together to really get what you want. You want to make sure your plan is efficient in all areas. 


Today we’re going to talk about tax planning as it relates to investing and there are really two sides to this. We have some great guests and have broken this segment into two parts. To get started, we’ll be speaking with Guy Riccardi.


Managing Taxes In Your Brokerage Accounts 


Guy Riccardi is one of our money managers and he’s going to be talking about how they look at tax planning, especially when it comes to non-qualified accounts. This is not your IRA or Roth, but other money that you put aside and how that’s taxed because that’s a little different.


So Guy, why don’t you just talk a little bit first about who you are and where you’re from? Give us a little bit about that background. 


Guy Riccardi: 

I’m Guy Riccardi and I’m a certified financial planner and portfolio manager here at United Asset Strategies. We’re a wealth management firm that specializes in active portfolio management, and what we really focus on is we try to get risk-adjusted returns for our clients by building out portfolios utilizing individual stocks, well, really individual security selection. So that means we’re going to be going in and buying actually individual stocks and individual bonds right in our client accounts. 


That’s a little bit of a differentiator for us versus what a lot of other advisors are doing out there. A lot of other advisors rely on pooled securities, whether it be mutual funds or ETFs, to be building out their portfolios. 


We find it’s really important to be focusing on utilizing those individual positions because it can better allow us to handle overall market volatility and risk management within the individual accounts.  Then additionally, like you were mentioning, it also allows us to be much more tax-efficient when we’re actually managing non-qualified accounts. 


How Do I Reduce Taxes On My Investments?


Michelle Bertram: 

If I have a non-qualified account and I have it in mutual funds or ETF’s, how does the tax situation work with those? Also, what are some of the things that you do to reduce the tax or be more efficient that way? 



Guy Riccardi: 

I think anyone that is a mutual fund investor or has had some history with that, know that each year you get something called a capital gain distribution. So that comes out at the end of each year. A lot of times they payout in December and it kind of looks like a dividend that comes out. 


That’s inherently the kind of activity that was going on within the overall fund through the course of the year. Unfortunately, a lot of times those capital gain distributions are being driven by the other investors within the fund.


So you yourself, as the investor in the fund, could have been holding it throughout the whole year. But if other people were selling the fund through the course of that year, the fund manager actually has to come up with those cash redemptions, and he does that by selling securities. 


Now a lot of those securities have gains in them. And what happens is they then have to realize a bunch of these gains through the year, and it ends up getting distributed out proportionally to the investors that are still holding the fund at the end of the year.


Michelle Bertram: 

So I sometimes call this a “Phantom Tax” because you’re paying tax but you didn’t even realize this gain necessarily yourself. 


Guy Riccardi: 

Yeah, absolutely. And what can be even most frustrating as you find in sometimes the most volatile years and years that you actually might not have grown within your account are some of the worst tax years.


Thinking back to 2018 where we had a big downflow in the fourth quarter, there was a lot of panic selling that was going on and some big capital gain distributions ended up coming out even though by the end of the year a lot of people’s accounts actually down for the year.


So it’s just the structure when you’re in a pooled security like that, it’s an example of the inefficiency there. 


What Is Tax Harvesting?


What we do differently is when we’re building out these portfolios with individual securities is, first off, we’re kind of looking at each person’s individual tax circumstances. 


Quote About Investing - Bertram FinancialSo usually the end goal is we’re always going to be trying to lower capital gains where we can and we do that through tax harvesting and tax swaps. Those are two important tools that we use to manage tax efficiency.


With tax harvesting, we’re identifying particular security and we’re really selling it purely to take the tax loss. You know, we might still really like the stock or the bond, but at that time it’s more valuable to actually take the loss. We do that to offset other gains.


I also want to point to the fact when we’re talking about everyone’s individual circumstances, there might be a situation where we might even be realizing gains because someone might have carried forward losses. Or they might have other losses offsetting. 


Michelle Bertram: 

That makes sense, so you’re actively watching it.


From the reverse side, I’ve seen plenty of times where clients will come in and they have this big portfolio consisting of mutual funds a lot of times, but sometimes stocks too or  ETFs and it might be riskier than they want or more aggressive than they want, but now if they want to try to sell anything or do anything, they have huge capital gains.


That’s something that we can help with if that is the case, there are ways to lower the risk and manage the taxes efficiently. But what you’re doing is making sure that that doesn’t happen in the first place. 


So we’re watching the risk all along, but we’re making sure that when they do need to sell it for whatever reason, they’re not holding this thing just because it has a big capital gains tax, right? 


Instead, it’s all being coordinated. We’re holding it for multiple purposes and we’re not just going to let it sit there and grow the tax burden. 


Guy Riccardi: 

Yes, and unfortunately you find a lot of people get into that circumstance, especially after holding for a long period because in the pooled security you’re getting the blended return of the overall portfolio, which over time you want to be growing is and hopefully, is growing. But then when you actually go to sell it, it’ll have issues with the capital gains like you mentioned.


What’s frustrating is if you actually dove down into the blended portfolio, inherently there are positions in there that have losses. 


But you can’t carve them out and actually sell the ones that have the losses to be offsetting other gains. 


Michelle Bertram: 

Just to clarify for everyone, that pooled structure is any type of mutual fund, bond fund, or ETF fund.


There are positions inside those pooled funds that have a gain or loss, but we have to sell that whole fund, not just parts of it.


So the last thing I want to hit here is this, “Why do you think more advisers or managers don’t manage this way?”


It makes sense. Why not look at the taxes and reduce the taxes? 


If you reduce tax, you end up making a better overall net rate of return too because you’re paying less tax. 


Why do you think most managers don’t do it? You know I’ve heard others talk about it, they know the terms and they might mention them, but they don’t actually do it.  


Guy Riccardi: 

Well, part of it is because it’s not easy and it’s labor-intensive. You need to have a good infrastructure built behind you to actually efficiently execute all of this. 


You have to have team members whose individual responsibility is just to be following the stocks on a day by day basis and following their sectors executing block trades. 


They can’t also be client-facing at the same time, because if someone is in a meeting with a client that could be the time you need to be executing a trade. 


So you need to have the infrastructure built up to do it and the patience to deal with the labor intensity around it.


Whereas what the mutual funds and ETFs do bring is one tenement that we find very important within portfolio construction and its diversification. 


So you can build out a diversified portfolio that has a lot less activity in it utilizing those ETFs in the mutual funds and you don’t have to have that building infrastructure behind you.


So that’s really, I think, a big reason why you don’t see it as much within the industry.  


Michelle Bertram: 

Right, because it’s actually more work for the advisors and managers.


I find that a lot of people in our industry sometimes take the easy money, right? They do whatever they can for the least amount of work. 


Then it becomes an industry standard and that’s something we don’t want to do.

Thanks for sharing that. We have some other interviews where we’ve talked more about the inefficiency of funds in general, be sure to check them out. Thanks for joining us Guy.

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