Fallout from the pandemic in 2020 caused massive market dislocations and a bevy of asset purchases and sales. A good deal of that activity resulted in taxable events for sellers, and for many, an unwelcome tax bill.
Efficient tax strategy can make a big difference in your investment portfolio returns over the long term. The products you choose may affect your tax bills along the way, as will the timing of your asset sales. Smart decisions in these two areas can add up and make a meaningful difference in after-tax returns.
Tax Efficiency in Your Portfolio
Did you know that ETFs are generally more tax-efficient than mutual funds? This is due to an organizational feature that allows an exchange-traded fund to buy and sell holdings without passing through gains and losses to holders of the fund until the holder sells that ETF.
An active mutual fund, on the other hand, does book gains and losses when assets are sold by the managers and passes them through to the customer at the end of the year. Not knowing ahead of time what those gains or losses look like can make tax planning difficult.
With ETFs you’re in more control of your tax destiny, whereas in a mutual fund, that control is in the hands of a portfolio manager. For that reason, some advisers recommend that mutual funds are more suitable for tax-advantaged accounts.
Using Time to Your Advantage
Anytime you decide to sell an asset, you should use some type of checklist to ensure you make an informed decision. Included in that checklist should be items such as asset type, valuation, momentum, alternatives for the money, and then there is the subject of holding period and tax.
When deciding whether to sell or hold, don’t forget about the time variable. If you sell an asset you’ve held for a year or less, it is treated as a short-term gain and taxed as ordinary income. Long-term gains are taxed at 15% for most Americans. But remember to take all variables into account when deciding what to do. If you feel an asset you’ve held for less than a year has neared a high or plateaued, sometimes it doesn’t make sense to wait for the asset to achieve long-term status. You could be risking a pullback in the asset that exceeds the difference between long- and short-term tax treatment.
For someone in the 22% tax bracket, waiting to sell is a bet that the asset won’t decline by 7%. Also consider the same thing in dollar terms. On a $1,000 gain, the difference in tax between the long and short gain is $70. Would you risk losing the entire $1,000 gain to save $70?
That question may be thought of differently for someone in a higher bracket, and different still for someone who has short-term losses to offset a gain. How about someone on the edge of being eligible for the Alternative Minimum Tax? They may be quite happy to hold the asset and take their chances rather than risk paying extra taxes.
Every sell/hold decision is unique unto itself and thus, there are few universal rules. In this dynamic environment, a checklist can help you make informed decisions regarding the if, what and when to sell. Go over that checklist and remember to consider all the factors involved, every time you make a sell/hold decision.
For a sample checklist of things to consider when you’re thinking about buying or selling, visit the Frazier Investment Management Blog at https://frazierim.com/fim-blog/frazier-investment-management-sellhold-checklist.
* Securities and advisory services offered through LPL Financial, a registered investment adviser. Member FINRA/SIPC.
* Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisers regarding the tax consequences of investing.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Securities and advisory services offered through LPL Financial, a registered investment adviser. Member FINRA/SIPC.
Brian Murphy is a Market Strategist and Investment Manager at Frazier Investment Management in Southern Rhode Island. Before joining the Frazier team, he served in the U.S. Navy for 11 years as a carrier jet pilot. Brian has experience managing several different strategies and products, including equity, fixed income, long/short portfolios and options. He believes that managing risk is the key to successful outcomes and works with clients nationwide to achieve their investing goals.
Six Steps to Take if You've Recently Inherited Money From a Loved One
It’s important to deal with the emotional aspect first before tackling the financial one.
By Kiplinger Advisor Collective Published
Alaska Airlines to Buy Hawaiian: Get Bonus Miles Now
How to use the Alaska Airlines credit card and frequent flyer program to save on trips to Hawaii, Alaska and beyond.
By Ellen Kennedy Published
11 Reasons to Consider a 1031 Exchange
Deferring capital gains taxes might be at the top of the list, but growing your portfolio and your wealth and helping with estate planning are also compelling reasons.
By Daniel Goodwin Published
Why It’s Time to Give Bonds Another Look
Yields are much more attractive now, but you should use discretion to find the bond allocation that’s best for you.
By Bill Aldrich, CLU® Published
Estate Planning and the Legal Quirks of Retiree Cohabitation
Creating an estate plan for an unmarried couple is already challenging, but when the cohabitating couple are in their golden years, it’s especially tricky.
By David Handler, J.D. Published
Seven Financial Planning Stops to Put on Your Map to Financial Security
Creating a comprehensive plan is just the start, though. Checking in regularly to make sure you’re still on track is imperative.
By Michael E. Lewis II, CFP®, CLU®, ChFC® Published
How to Measure the Health of Your Retirement Plan
These five key indicators can help you make decisions based on the overall performance of your retirement plan rather than individual variables.
By Brian Skrobonja, Chartered Financial Consultant (ChFC®) Published
Four Easy Ways to Get Yourself Fired
Being a standout on the job can sometimes be as simple as showing up to meetings on time, responding promptly to requests, doing your homework and not being a jerk.
By H. Dennis Beaver, Esq. Published
How Might the Great Wealth Transfer Change Society?
As $84 trillion in assets move from Baby Boomers to younger generations, we could see a greater emphasis on financial technology and investing based on values.
By Jennifer Wines, JD, CPWA® Published
Why More Retirees Might Come Out of Retirement
It’s often not solely because of financial reasons, but because of a lack of purpose in retirement. This financial expert can relate.
By Chris Blunt Published