Specializing in Tax-Friendly Investment Strategies

Since the turn of the century (2000) investors have not had to think much about tax-friendly investment strategies due to two major bear markets. But times have changed. The stock market is near all-time highs and many, if not all, of investors' loss carry forwards have been used up. More importantly, the Obama administration has already raised tax rates on the wealthy and the outlook is for tax increases to broaden as part of the solution to taming our debt and deficit problems. The bottom line is that investors need a new strategy for this environment. Tax-friendly investing is an area of strength and expertise for our company. In fact, one of our strategies goes back 15 years and has outpaced the S&P 500 on an after-tax basis over that time horizon ! Below is a review of the techniques we use to maximize after-tax returns:

Buy & Hold - The best strategy for the tax-conscious is to buy and hold high quality companies.As long as a stock is held, gains can grow tax free -- only dividends are taxed.For this strategy to be successful, the keys are (1) find companies with profitable, long-term growth opportunities and (2) pay a fair price for the stock.The foundation of our stock selection process is focused on trying to find these types of companies.

Harvest Losses When Economical - The stock market's volatility makes losses inevitable even in bull markets for at least some of the stocks in a diversified portfolio.When losses occur, selling that stock will book a tax loss, which generates an asset for the investor.These losses can then be used to offset current or future gains helping to minimize taxes and maximize after-tax returns.In cases where we still like the stock, we will buy back that same stock after 31 days (thus avoiding the IRS "wash-sale" rule) and hopefully benefiting from the stock's recovery.A key element of our approach is that we harvest losses throughout the year instead of just pursuing this strategy at the end of the year.

Choose the appropriate account type for a given strategy - Some strategies within a diversified framework will not be as naturally tax-friendly as a basic buy & hold strategy.For example, any strategy that by nature involves active trading and high turnover (i.e. many small capitalization strategies) is likely to generate more short-term capital gains.High turnover or high yielding portfolio management approaches should be placed in tax-exempt accounts such as IRAs or 401Ks, all other factors being equal.

Avoid Mutual Funds for Taxable Assets - Mutual funds are very tax-unfriendly.The key drawback with mutual funds is that the shareholder surrenders their ability to control their individual tax liability.Specifically, there is no opportunity to harvest losses as there is in an individually managed account.Moreover, a mutual fund shareholder could be penalized by the actions of other investors in the fund.If others panic and sell their mutual fund shares at the bottom, the fund manager is forced to sell stocks to meet the redemptions, potentially generating a tax liability for the remaining shareholders.

Use Low Cost Basis Stocks for Charitable Giving - Those who are charitably inclined should use appreciated stock for their gifting, instead of writing a check and using after-tax dollars.If you paid $1000 for a stock that is now worth $5000, and you held the stock at least a year, you can give this stock to the charity, and receive a tax deduction for the whole $5000, while avoiding any taxes on the $4000 gain. (Keep tuned, however, as these benefits may change as Congress contemplates new tax legislation).

A Final Thought :While we do our best to minimize taxes a mentality of trying to avoid taxes at all cost should be avoided.When a stock is significantly overpriced, we will sell the stock and wait until the valuation drops to attractive levels before buying again.There are times when realizing gains (and paying taxes) is the best decision to maximize after-tax returns.

Be sure to call us if you have any questions.

Best Wishes,

Jim Tillar, CFA

Steve Wenstrup

© Tillar-Wenstrup


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