There are many ways that a good advisor boost returns. One of them is tax efficient investing. It was with interest, therefore that I read an article in Investment Advisor magazine by David Lau entitled, “Dispatches from the Tax-Efficient Frontier.” It claimed:
New research shows that tax deferral can potentially increase returns on tax-inefficient assets by as much as 100 bps—without any subsequent increase in risk—simply by locating assets based on their tax treatment between taxable and tax-deferred vehicles.
Investment advisors break 1% down into one hundred parts, each called a basis point. Basis points, each one hundredth of a percent, are abbreviated bps and often nicknamed “bips.”
Boosting returns by 100 bps is a big deal. It means that tax efficient investing alone might earn more than advisors charge making the remainder of their services just an additional benefit.
Lau went on to explain part of how to implement tax efficient investing:
Tax-efficient assets, such as index funds and passively managed funds, generate long-term capital gains and dividends, currently taxed at rates of 15% or less. Tax-inefficient assets, including bond funds, REITs and many hedge-like funds, generate ordinary income or short-term capital gains, currently taxed at rates as high as 35%. Actively managed investments can suffer the biggest hit – short-term capital gains tax plus the added cost of multiple transaction fees.
A textbook asset location strategy would put all tax-efficient asset classes in taxable vehicles, and all tax-inefficient asset classes in tax-deferred vehicles.
Lau quoted one advisor as saying, “A quality advisor recognizes that tax-deferral is crucial—I don’t know of anyone who couldn’t benefit from it in some way.”
Tax efficient investing doesn’t show up on performance reporting, but it boosts your after tax wealth none the less.