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14 November 2018

Pulling the Plug on Unnecessary Taxes

We all know the importance of establishing a target asset allocation for a client. It becomes a bit trickier to maximize the clients’ after-tax returns when they own multiple accounts with different custodial registrations. So how do you implement a target asset allocation across all these different accounts and optimize after-tax returns?

In this post, we cover a brief history of retail investing, the clear movement toward optimal household management and the vital role of tax-smart asset location:

Prior to the 1980s, retail investing was simple; stocks and bonds were sold by a broker, and we put cash in the bank.

With the advent of sky-high interest rates in the early 1980s, money flowed out of banks into cash management accounts at brokerage and “no-load” mutual fund companies.

Interest rates fell through the ‘80s causing trillions of dollars to flow into mutual funds with investors too often buying high and selling low, all while chasing performance and collecting an array of 5-star mutual funds. Some called this “asset allocation by accident or default.”

Through the 1990s and into the 21st century, investors continued to buy new and improved versions of managed money with strategies like managed models, separately managed accounts, annuities, unified managed accounts, alternative investments, ETFs and robo products – all in a quest to mitigate risk and improve outcomes. But, given the complexity of achieving tax-smart asset location, household portfolios lacked coordination among products and accounts.

This resulted in the typical investor owning five or six accounts with a range of registrations and multiple product types, usually managed by two or three advisors. In their quest to diversify products and advice sources, investors weren’t aware of, nor able to achieve, tax-smart asset location and as a result now find themselves paying unnecessary taxes.

Asset location is defined as creating a household level asset allocation and then locating investments in the optimal account registrations. A general rule of thumb is to place tax-inefficient assets in qualified accounts and tax-efficient assets in taxable accounts. The objective: to reduce taxes paid and maximize after-tax returns. Several research papers have demonstrated how asset location can improve after-tax returns by 50-100 basis points per year by organizing the household through tax-smart asset location, and play a tremendous role in improving investor outcomes. The papers advocate that advisors should provide this level of advice but don’t show how to get it done.

LifeYield and Black Diamond have partnered to help advisors help investors achieve optimal asset location by 1) providing the Taxficient Score®, an easy metric that analyzes the tax-efficiency of any household and quantifies the dollars and cents benefit of coordinating all accounts, and 2) showing advisors how to implement the recommendations across multiple accounts and products. The result: Advisors and investors achieve improved after-tax returns, more rapid accumulation of wealth, the ability to quantify and demonstrate the value an advisor provides and increase asset retention and consolidation.

Forward-thinking firms have invested tremendous resources into trying to solve this puzzle. But one thing all these firms lacked was a tool to help measure in dollar and cents how well the client is doing, and an ability to graphically illustrate with a prospect or client how much financial – and advice – value is being added through tax-smart household management.

Like a credit score, the Taxficient Score assesses the tax efficiency of all an investor’s accounts on a scale of 0-100. The higher the score, the better positioned the investor is to minimize taxes in order to make and keep more money as well as achieve retirement goals. Studies show the average investor household has a Taxficient Score of 53, which indicates retail investors are half as tax efficient as they could be.

Through LifeYield’s integration with Black Diamond, an advisor can pull all associated accounts for a client or household into LifeYield, create a Taxficient Score and run a proposal which quantifies the client benefit of Tax-Smart Asset Location.

To learn more about how to help your clients optimize their asset location, visit