Even as volatility leaves financial advisors’ clients wondering how to address their portfolios, it’s important to remember that certain choices — such as developing a tax-efficient investing strategy — can make a big difference no matter the market environment.
Christine Benz, Morningstar’s director of personal finance, recently outlined her top investments for taxable accounts in an updated column on the firm’s website, and shared insights with ThinkAdvisor on how financial advisors might approach these decisions with clients.
“There is increasing awareness among advisors that tax management is one of the most valuable services they can provide for their clients,” she told ThinkAdvisor via email. “Advisors can’t control how the markets behave or the rate of inflation, but tax management is an evergreen way to add value.”
The starting point for advisors and clients is a discussion on the eventual goals for the funds, which in turn can determine the right asset mix and the proper tax strategy, she said.
“From there, it’s important to discuss tax bracket — right now and in future years,” she said. “That way, the advisor can develop a holistic, long-term tax strategy — one that aims to limit taxes in the here and now but also the taxes that are eventually due when the client sells the asset.”
Tax bracket is “a crucial consideration,” Benz continued. “If a client is in a lower tax bracket, investments that would otherwise be tax-inefficient, such as taxable bonds or high-dividend-paying securities, might make more sense than would be the case for people in higher tax brackets. Additionally, clients in that situation may want to take advantage of selling appreciated securities at the 0% capital gains rate and even re-buying them, thereby boosting cost basis and reducing the taxes due on the eventual sale.”
Advisors rarely create portfolios from scratch, “so a big part of the discussion will necessarily be about how to transition a portfolio with tax-inefficient investments to one that is more tax-friendly and appropriate for a taxable account,” she added. “Unfortunately, making a portfolio more tax-efficient can bring its own tax bill if it means selling out of something that has appreciated.”
The recommended investments for taxable accounts are fairly constant, regardless of the economy, but financial advisors and clients should pay attention to any changes to the tax code, she said.
“Last year, when we pondered curbs on the amount of assets that would be eligible for a step-up in cost basis upon death, for example, that prompted a major reconsideration of strategies that advisors had been using for many years,” although such changes didn’t materialize, she noted.
Here are six of Benz’s top investment picks for investments for taxable accounts (versus tax-preferred accounts like retirement plans), per her Morningstar column, which notes that investors have access to an increasing selection of tax-efficient model portfolios.