Author: Jesse Mackey

This article represents part 2 of 3 in this series. Please see yesterday’s post as well as tomorrow’s for the full article.

In the event that assets cannot be invested in an account/plan that allows for tax deductions, tax deferral, or tax elimination, the following seven techniques are excellent ways to reduce the tax burdens associated with investing in currently taxable accounts, such as jointly titled, trust-owned or individual accounts, which may come in the form of brokerage accounts, fee-based managed advisory accounts, or direct subscription investment vehicles.

Municipal Fixed Income – Possibly the most traditional method of tax minimization for high income tax bracket investors is the use of bonds issued by government municipalities, which are typically free of income taxation if purchased by an investor that resides in the state in which the security is issued, even if purchased within a currently taxable account. Muni’s are useful both for tax minimization purposes and for portfolio diversification purposes, but may not be beneficial in large quantities for all investors.

Low Turnover Managers – When purchasing mutual funds or hiring individual security Separately Managed Account (SMA) managers, it is useful to consider the amount of active trading that will occur in the fund/account during the course of the year, as this will often be indicative of the amount of capital gains taxes (short term and long term) that will be realized in an up-market scenario. Lower portfolio turnover often indicates lower realized (as opposed to unrealized) capital gains, whereas higher turnover managers may indicate a higher propensity to generate tax liabilities for the investor.

Separately Managed Accounts (SMA) and Individual Stocks – It is often cited that the use of individual securities (stocks and bonds) in a brokerage account or SMA will, all things being equal, generate lower current tax liabilities for investors than the use of mutual funds. This is because mutual funds, as pooled investment company vehicles, may distribute capital gains and dividends to all investors regardless of whether the individual investor was able to participate in the full benefit of the appreciation in value of the underlying holdings of the portfolio (because the fund may have been purchased after the majority of the price appreciation, but before distribution of the full capital gain liability by the fund). SMAs are not pooled investment vehicles, and therefore holdings purchases/sales are specific to the individual investor, allowing managers to actively customize the transactions in the portfolio to the tax situation of the individual, thus reducing unwarranted tax liabilities.

Fund Dividend and Capital Gains Distribution Awareness- The flipside of the above argument regarding the tax-efficiency of individual securities is that a portfolio composed of mutual funds, if managed properly, may be just as tax efficient as an individual-securities-only portfolio while also providing the investor with the full investment diversification necessary to reduce long term portfolio volatility. If this is to be accomplished, the mutual fund portfolio manager must make purchases and sales of the component mutual funds with an awareness of any upcoming fund dividend or capital gains distributions in order to avoid these if unwarranted for the investor, and to avoid “selling dividends” which is a prohibited practice. The mutual funds may also be selected based on the manager’s professed tax-efficient style of investment, or based on a history of asset type tax efficiency.

The series concludes tomorrow…to be continued…

Jesse Mackey is a partner and Investment Officer of 4Thought Financial Group Inc. 4Thought was created with the base vision of advancing individual freedoms and the human quality of life through economic means. This vision is pursued by applying the firm’s four specialties – Economic Theory and Research; Multi-Contingency Investment Management; Financial Planning for Business Owners and Individuals; and Support for Partner Firms and Advisors.

Contact:

Jesse Mackey

4Thought Financial Group Inc.

www.4TFG.com

jmackey@4TFG.com

Author: Jesse Mackey [1]

Why is this Topic Important to Wealth Managers? This blogticle represents part two a special series regarding advanced investing with ETFs. Recently there has been much discussion in the marketplace on the use of these tools and thus we present this topic for wealth managers who may consider these investment vehicles for their clients.

The existence of numerous disparate portfolio management methodologies in the institutional investment management world has not slowed the growth in popularity of Exchange Traded Funds (ETFs) and other Exchange Traded Products (ETPs) in the last several years. In fact, possibly the most convincing reason for the enormous popularity and success of ETFs is that they are so versatile. They are not designed for any one philosophy of investment, but can play a role in many different investment methodologies. Presented below are a few examples:

Passive Management Strategic Asset Allocation- For wealth managers and clients that use strategic asset allocation and adhere to a strict “Efficient Markets” view of the financial world, an entire diversified portfolio allocation may be built using ETFs, thereby minimizing costs/expenses to the investor, optimizing the transparency of the investment, and reducing risks associated with specific managers.

Active Management Strategic Asset Allocation- For wealth managers and clients that prefer to use actively managed components for the majority of the strategically allocated portfolio, they may also use ETFs to gain exposures to specific sectors that are not otherwise present in order to “round out” the allocation. They may also choose to use an ETF for the part of the portfolio devoted to the “efficient” markets, while the “inefficient” markets would be covered by an actively managed fund or separately managed account.

Tactical Asset Allocation and Absolute Return- ETFs have gained a great deal of popularity amongst wealth managers and clients that prefer to tactically shift the portfolio in anticipation or reaction to market events or other factors in an attempt to outperform the market. These investors are seeking to outperform (to the downside or the upside) not by selecting individual stocks or bonds, but by having an awareness and specialization in the qualitative/quantitative relationships between different areas of the market. ETFs allow them to have this specialization because they do not need to spend their time in finding stocks/bonds to fill out their allocation and can instead focus on inter-market relationship analysis.

Liability Driven Investing- The highly specific mandates/indexes associated with many ETFs mean that they are an excellent tool for Liability-Driven Investing (LDI). Passive Bond ETFs, industry-specific funds, leveraged ETFs, short ETFs, and the ability to buy/sell options on some ETFs make particularly attractive tools for this philosophy of investment, which focuses on hedging and insuring against risks as opposed to seeking risk-adjusted market returns.

Next week’s blogticles will present a discussion on wealth management and investing in tough economic conditions.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Jesse Mackey is the Chief Investment Officer of 4Thought Financial Group Inc. 4Thought is a boutique think tank created with the base vision of advancing individual freedoms and the human quality of life through economic means. This vision is pursued by applying the firm’s four specialties – Economic Theory and Research; Multi-Contingency Investment Management; Financial Planning for Business Owners and Individuals; and Support for Partner Firms and Advisors. You may contact Mr. Mackey at jmackey@4TFG.com or visit www.4TFG.com.

Author: Jesse Mackey [1]

Why is this Topic Important to Wealth Managers? This blogticle represents a special series regarding advanced investing with ETFs. Recently there has been much discussion in the marketplace on the use of these tools and thus we present this topic for wealth managers who may consider these investment vehicles for their clients.

Since the advent of ETFs (Exchange Traded Funds), these investment vehicles have rapidly grown to account for a significant portion of the daily trading volume on the world’s major exchanges, and by some estimates will account for the majority of trading volume during the next decade. But despite the widespread use of ETFs in the institutional investment world, few individual investors or their wealth managers really have a firm grip on the uses or purposes of these instruments. Although there are many different flavors of ETF, generally speaking ETFs can be described as a mutual fund designed to passively track a specific securities index that can be traded like a stock on an exchange. This leads us to identify several attractive characteristics of ETFs for your clients:

Transparency of Indexes – Most ETFs (though not all) are designed to replicate the performance of a specific index, which is in turn designed to mimic the performance of a specific financial market (i.e., large cap stocks, short term corporate bonds, etc.). As a result, the client is able to achieve direct exposure to the specific area of the financial markets that is being targeted, without much question as to the “style drift” or the management methodology of the underlying portfolio. There is a great deal of transparency and clarity for the investor as to the reason and timing for transactions placed within their ETF holdings.

Lower Manager-Specific Risks- In index-tracking ETFs there is a lower degree of exposure to active manager-specific risks for the investor. Since the ETF is designed to passively follow an index regardless of the positive or negative performance of the underlying securities, there is very little exposure to the risks associated with the potential underperformance of any one active manager, which would otherwise be present with a traditional actively managed mutual fund. The average active manager has a tendency to over-perform the index in some years and under-perform the index in others, whereas the passively managed ETF is intended to do exactly what the index does, and so will not dramatically over or under-perform, by design. However, ETFs do have a form of risk known as tracking error, in which the ETF itself may not exactly replicate the benchmark index, due to a multitude of factors.

Intraday Tradability – ETFs are traded in real time on an intraday basis on an exchange, as opposed to being redeemed daily by the mutual fund company (like a traditional open-end mutual fund). As a result, investors are able to buy or sell the security with greater control over the timing and price. As with shares of stock, investors can place market orders, limit orders, stop orders, etc. This creates opportunities for active management that would not otherwise be available with a traditional mutual fund.

Targeted Exposures – ETFs allow your client to gain targeted exposures to very specific sectors or areas of the financial markets, while still maximizing numerical security diversification to the extent possible within the selected market, and without having to select individual securities (stocks, bonds, etc.). For example, a client could select an ETF that provides exposure to US Consumer Staples stocks, which might have an underlying portfolio of 40-100 stocks that provide access to an entire sector of the economy. This has implications for portfolio management both from the strategic asset allocation perspective, and for tactical asset allocation methodologies.

Low Turnover and Tax Efficiency- One commonly cited reason to consider using ETFs is for the purposes of tax efficiency relative to traditional mutual funds. Traditional actively managed mutual funds may have a high degree of underlying portfolio turnover as a result of the rapid buying and selling of securities. High volume/frequency transactions can produce tax liabilities whether the purchase/sale was ultimately beneficial for the overall portfolio or not. Because ETFs usually track an index, which often will not experience a large degree of change in the components over short periods, ETF turnover ratios are usually very low. In addition, as a result of the “Creation Unit” structure under which ETFs are issued, the holder’s exposure to taxation due to fund redemptions is reduced or eliminated. All things being equal, these features may result in less tax liability for the investor when it’s time to file the return.

Tomorrow’s blogticle will continue our special series on ETFs.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Jesse Mackey is the Chief Investment Officer of 4Thought Financial Group Inc. 4Thought is a boutique think tank created with the base vision of advancing individual freedoms and the human quality of life through economic means. This vision is pursued by applying the firm’s four specialties – Economic Theory and Research; Multi-Contingency Investment Management; Financial Planning for Business Owners and Individuals; and Support for Partner Firms and Advisors. You may contact Mr. Mackey at jmackey@4TFG.com or visit www.4TFG.com.