Minimize Taxes with Asset Location
It all begins with an idea.
Most of us know that taxes on bond interest differs from the tax paid on stock dividends and capital gains. What we think about less however, is how to optimize the after tax returns of investments based on our mix of taxable and retirement accounts.
A clear example of tax optimization can be observed with Municipal bonds. Frequently, investors holding assets in a taxable account choose Municipal bonds as an investment, while investors with assets only in retirement accounts do not. Municipal bonds typically incur no federal income taxation, however they also typically pay a lower interest rate than their taxable bond counterparts. In taxable accounts, the after tax yield of a Municipal bond will frequently be higher than the after tax yield of a corporate bond of similar credit quality. So, if the after tax yield is higher, many investors will rationally choose to invest in Municipal bonds.
How does this after tax logic translate to taxable bonds and stocks? Many think that because bonds have higher current tax burdens than stocks, it means they should be held in retirement accounts. However, the answer is not that clear cut. Many factors such as years to retirement, future interest rates, and expected future equity returns change the calculus of those decisions and make after tax return projections hard to determine. There is no clear cut right or wrong answer on how to allocate these investments between taxable and retirement accounts, but here are some general guidelines that may be helpful.
If you are near or in retirement, and hold both taxable and tax advantaged accounts, think about holding your bonds in your retirement account and your stocks in a taxable account.
If you are still in the accumulation process (i.e. are younger), allocating both types of accounts in a similar manner is a prudent way to go. For example, if you have 70% stocks and 30% bonds in your taxable account, create the same allocations in your tax advantaged (retirement) accounts.
For all investors, place international investments in taxable accounts if possible. This is because frequently you are paying foreign taxes on your investments even if they are held in retirement accounts.
Always try to hold REIT's in retirement accounts. They pay high dividends that are almost always taxed at ordinary rates (like taxable bonds) so it is much more efficient to hold them in tax advantaged accounts.
There are many nuances to tax location and tax efficient investing, and of course the statements above are opinions and should not be taken as fact or as tax advice. If you have any questions,or would like to discuss further, please feel free to contact me at paul.hegdahl@hegdahlim.com or 415.309.3472.
The Fiduciary Standard: Investment Advisors vs Broker Dealers
It all begins with an idea.
In realm of investment advice investing , there are two primary channels that provide advice: investment advisers (which is our role), and traditional brokers who are employed by broker-dealers
The fundamental contrast lies in the fact that investment advisers are mandated by the Securities and Exchange Commission (SEC) to function as "fiduciaries," while brokers are obligated to adhere to a "suitability" standard.
As per the SEC's regulations, a "fiduciary" is obliged to prioritize the interests of their clients consistently above their own. On the other hand, the "suitability" standard that broker-dealers must meet only necessitates that an investment be considered suitable for a broker to recommend it.
The suitability standard can give rise to conflicts between a broker-dealer and the underlying client. The most apparent conflict relates to fees. Under a fiduciary standard, an investment adviser is strictly prohibited from acquiring a mutual fund or any other investment solely to earn a higher fee or commission. However, under the suitability requirement, this is not necessarily the case. As long as the investment is suitable for the client, it can be recommended and purchased. The suitability standard permits brokers to promote their own products ahead of potentially superior alternatives, which their firms often incentivize them to do. Furthermore, many brokers earn commissions from trades, creating an incentive to engage in frequent trading within client accounts to generate fees.
In the case of our firm, we believe that our incentives are genuinely aligned with the interests of our clients. We do not impose commissions and do not receive compensation for promoting specific investments. Our sole interest lies in safeguarding and increasing the value of our clients' assets because we are remunerated based on a percentage of those assets. If a client's assets appreciate, our compensation increases, and if they depreciate, our compensation diminishes. We see this alignment as completely eliminating conflicts of interest, fostering an environment where we prioritize the best interests of our clients.
When seeking someone to assist with your investments, a crucial question to pose is, "how are you compensated?" While it might be a challenging question to ask, it is vital to consider that the financial incentives of your money manager can significantly impact the long-term value of your portfolio.
For any questions on this or other topics please feel free to reach out to paul.hegdahl@hegdahlim.com or (415) 309-3472.