As a volatile 2022 for the stock and bond markets comes to a close, year-end portfolio planning is front of mind for millions of advisors, their end clients, and self-directed investors. ETFs have been popular, with net inflows approaching $600 billion, but there remains a lot of money in expensive, tax-inefficient stock-only or stock-and-bond-based mutual funds in taxable accounts. Most investors have the capital gains, dividends and interest distribution toggled to reinvest as they come in on a quarterly or annual basis, but each of these reinvestments is its own tax lot creating a particular opportunity this year for the well-prepared advisor.
“These holdings are generally reported on the statement as the aggregate performance of each of the tax lots, which is a detail that most investors are unaware of,” explained Vance Barse, wealth strategist and founder of Your Dedicated Fiduciary. “A mutual fund that was purchased in 2015 may have the original tax lot that is still up, but actually have a few tax years like 2018, 2021, and 2022 with tax lots at a loss.”
By converting from the average cost basis, shown on the statement, to a tax-lot-specific cost basis using software like , advisors and clients can see which of these tax lots are down and sell out of them to create a loss, added Barse. The loss can be carried forward and is a very effective tax planning strategy. The resulting cash can be reinvested in significantly lower cost holdings that are more tax efficient for the future.
For investors that plan to stay invested for another 20 or 30 years, a move from a mutual fund that charges a 1.0% annual expense ratio to an ETF that charges just 0.03% would have tremendous benefits. There are many low-cost ETFs to consider including the , the , and the that all track the same prominent S&P 500 benchmark for a 0.03% annual fee.
Other ETFs available for the same low fee include the , the , and the , which track modestly different benchmarks than one another and the aforementioned S&P 500 based ones. Owning different stocks will impact the performance of these ETFs going forward.
Barse told VettaFi that “I hear it all the time from clients who transfer in assets ’I can’t stand the annual capital gains taxes from these mutual funds because I can’t control them!’ Well, taking a tax-loss specific cost basis approach can help solve that problem and keep way more money in their estate over time while dropping their annual capital gains burden.”
At the in February in Miami, a session on will potentially cover topics like this as part of the NextGen Practice track for advisors. I hope to see you there.
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