Designing a Personalized Portfolio: Three Principles to Unlocking Client Alpha
Active tax management is a key element of any wealth management plan.
Principle 2: Active Tax Management
Active tax management is a key element of any wealth management plan. While it is difficult to pinpoint what percentage of after-tax return is added through tax alpha, our in-house study shows that it may be up to 121 basis points.1 Over time, this can have a significant impact. Furthermore, the lack of tax management can cost an investor as much as 25% of returns.2
At City National Rochdale, we take a methodical three-step approach that is a function of open communication among the client, financial advisor, tax professional, and portfolio manager:
STEP 1: Planning and Tax Budget
One key element of the Investment Policy Statement is tax. We formulate a tax budget for each client which defines the annual budget for ordinary income, short-term gains, and long-term capital gains.
We work closely with the client’s financial advisor and tax professional (CPA) to develop and manage the tax budget.
From the very start of the relationship, when we transition assets to City National Rochdale, we proactively manage to the tax budget. That budget then becomes an ongoing part of the portfolio’s active management at City National Rochdale.
STEP 2: Asset Location and Implementation
As we begin building a client’s portfolio, the first consideration of active tax management is the concept of “asset location”—in other words, putting the right securities in the right accounts to create tax efficiency and maximize the client’s after-tax returns.
See below for a numerical example of our asset location strategy.
Asset location also applies to the mutual fund space. We typically prefer to minimize mutual fund holdings in high-net worth client portfolios, opting to own individual stocks and bonds as core holdings. However, we understand that there are situations in which mutual funds may be appropriate (particularly with regard to specific market niches). Mutual funds distribute their capital gains annually, which can provide a tax management challenge. Nevertheless, we strive to implement appropriate strategies to minimize the tax burden.
STEP 3: Tax Budget Management
Our portfolio managers take active steps toward managing to the client’s tax budget and finding efficiencies where possible through strategies such as:
-Long-Term Capital Gains
-Offsetting Gains with Losses
-Tax Lot Management
The key to tax management is ensuring that the financial advisor, the accountant, and the portfolio manager are all on the same page. We take pride in our work helping clients create and implement their own customized tax plans.
To learn more about these individual steps and strategies, please see our in-depth white paper, Tax Alpha: Enhancing Returns Through Active Tax Management, or talk to your local City National Rochdale senior investment consultant.