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How New Tax Law Affects Investment Portfolios: The Advisor and the Quant

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In this series, we provide our readers with two distinct perspectives on the same topic — one from an academic, the other from a practicing financial advisor.

If you have a question or two, please send them to us.

Check out the previous column here.

QUESTION: What is the impact of tax reform on investment portfolios?


Investment portfolios don’t have a life of their own. They exist to provide benefit to someone. In my world, this is a person who has saved for retirement and will need to deploy funds over a period of time in order to enjoy a similar (or better) standard of living than while they were working. So, rather than thinking only of the “investment” implications of change, we should be thinking on two levels first, how does the change impact the assets that comprise the portfolio and second, how does the change impact how people should use their portfolios?

When thinking about portfolio implications, remember that markets reflect all available information. Whenever there is massive change, like the tax reform bill, new information is created. As the edges of the new law are defined through regulations, private letter rulings and court cases, the winners and losers of the new law will become more evident. Markets are, in effect, a probability machine. Long before new information or interpretation of these rules comes out, investors both large and small are betting on what the landscape will become through their investments. The winners under each possible outcome, thus, already have the odds of each outcome baked into their stock price. Academics call this the “efficient market hypothesis.”

While a slight slant based on an educated, but unconventional, view may pay off in the form of greater returns, the best strategy for most retirement investors is to maintain diversification, both for the downside protection, in case your “bet” is wrong, and for the upside, because you may get a portion of the gain from an area of the markets that you may have otherwise overlooked.

The second level deserves the majority of a retirement investor’s focus because it is mostly within their control. Questions such as which account to withdraw from at which points in retirement, whether to contribute to Roth or traditional IRAs, and when to harvest a capital gain can create significant value under the new tax laws, with fewer “gotchas” (such as the alternative minimum tax) to contend with. Moreover, the appropriate tactics differ for each investor, which means that there is no “zero-sum game” where the smaller investor is fighting against the larger, more sophisticated investor for who will outperform (and who will underperform) the market as a whole.


This is a very tricky question! Taxes directly impact portfolios in two major ways. The first is through the direct taxation of capital gains, which reduces the power of compounding. The second is through the rate of appreciation of the stocks and bonds held in the portfolio. Although every investor’s portfolio will see a different result depending of their particular situation (please talk to a qualified advisor), we can attempt the following generalizations:

1. Changes to short-term capital gains: Minimal impact.

For an investor or trader constantly trading in and out of positions, the reduction from 39.6% to 37% the top bracket will be positive but minimal. Assuming an $100,000 portfolio generating 8% annual return, over a 20-year period, the resulting difference would be the difference between $254,530 and $245,123. After 20 years, that’s a 3.83% difference.

2. Changes to long-term capital gains: Minimal impact.

Given that the new tax law only changed the location of the break points, but not the rates themselves, the impact of taxes here is also likely to be small yet positive.

3. Changes to corporate rates: Significant, but likely already reflected in the prices of assets.

The reduction from a top rate of 35% to 21% has increased the after-tax income for many corporations. For example, Berkshire Hathaway generated a $65 billion gain in 2017, of which $29 billion was attributable to the new tax code. However, the myriad of Wall Street analysts has already made adjustments to their valuation models, so the market has likely priced in this increase in profitability and growth rates for a while now.

Finally, at the macroeconomic level, the bigger question is how the new tax regime will impact the federal deficit, and economic growth. For this one, your guess is as good as mine.

— Related on ThinkAdvisor:

Joe Elsasser, CFP, Covisum

Joe Elsasser, CFP, RHU, REBC developed Social Security Timing software for advisors in 2010. Through Covisum, Joe introduced Tax Clarity in 2016.

Based in Omaha, Nebraska, Joe co-authored “Social Security Essentials: Smart Ways to Help Boost Your Retirement Income.”

Ron Piccinini, Ph.D., Covisum

Renaud “Ron” Piccinini, Ph.D., came from France to America, finally settling in Omaha, Nebraska. He brings extensive experience in building world-class risk systems, supporting tens of billions of dollars in assets to Covisum. Previously, Ron co-founded PrairieSmarts, a software business. Ron wrote his dissertation on what are now known as “Black Swan Events.”


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