Taxes – the Silent Killer in Portfolios

KEY TAKEAWAYS:

  • Taxes can be a significant, often overlooked, drain on your portfolio’s performance.
  • Low-cost asset class funds and index funds are more tax efficient by nature, than actively managed mutual funds. That’s why we use them.
  • Mutual funds that employ a tax-efficient investment strategy can reduce your tax exposure significantly.

 

As many have learned the hard way, taxes are the silent killer in an investment portfolio. But, most investors don’t even recognize the impact of taxes because the actual cost of taxes they pay is not reflected in their statements. As a result, tax inefficiency can be a significant drain on your investment returns. Fortunately, you have several options for minimizing the impact of taxes on your portfolio.

  1. Maximizing the use of tax-deferred or tax-free investment vehicles such as IRAs, 401(k)s and Roth IRAs.
  2. Optimizing asset location. This includes placing the less tax-efficient investments in tax-deferred or tax-free investment vehicles.
  3. Utilizing tax-efficient investment options.

Let’s focus on utilizing tax-efficient investment options. Since our investment philosophy is based on the use of index funds and low-cost asset class mutual funds, it’s a very tax-efficient way to put your money to work. These mutual funds generally have a much lower turnover in their underlying investments than “actively” managed funds do. As some of you know, turnover is the sale and purchase of stocks in the mutual funds which, assuming the market is up, creates taxable gains within the portfolio. Index funds and low-cost asset class funds generally invest in a group of stocks that make up a specific category. Fund managers only sell those stocks when they are no longer included in that category, thus minimizing turnover in the portfolio.

At Soundmark, we go a step further by using mutual funds that employ a tax-efficient investment strategy within the fund. Fund managers evaluate the sale of securities within the portfolio and minimize gains wherever possible. They may do this by delaying sales of securities while maintaining the overall allocation goals of the portfolio or by offsetting capital gains with losses the fund incurred in other securities.

Though the benefits of this strategy may not be reflected in the performance reporting we share with our clients, we believe inexpensive, tax-efficient vehicles are an essential component of our investment consulting. That’s why we evaluate tax-efficient investment options with all clients.

LET US HELP

If you or someone close to you is concerned about the hidden costs and tax consequences of their investment decisions, please don’t hesitate to contact Soundmark Wealth.

 

Todd Flynn, CPA, CFP® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other successful and accomplished individuals to help them define their financial goals and implement an ongoing financial planning process.