How to correct some tax inefficiencies in your portfolio


Tony Giordano of Vanguard Personal Advisor Services offers some suggestions for how investors can correct some tax inefficiencies in a portfolio. 

Other highlights from this webcast:

Notes:
  • All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
  • This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
  • It is possible that funds will not meet their objective of being tax-efficient.
© 2016 The Vanguard Group, Inc. All rights reserved.  

Emily Farrell: I have a great question from Steven from Plano, Texas. Now we talk a lot about I think in the idea of building from scratch, but he asks, “Assuming your portfolio has some tax inefficiencies, the wrong type of fund, the wrong type of account, how do you begin to look at it and fix it?”

Tony Giordano: Yes, so, unfortunately, we see that quite a bit. So when we’re working with our clients, there’s, you know, several things that we could actually be doing to fix that problem. The first one is pretty simple, and it’s probably not going to move the dial all that much. But any future dividends, any future capital gain distributions on that particular fund, you know, we would suggest that you redirect that into a more tax-efficient investment within that account. So that’s one thing you can do. You know, a couple of other examples, there’s probably three or four things we talk to our clients about. One is you could take that tax-inefficient mutual fund, you could gift that particular security to charity. That would be a good way to get it out of your portfolio and no longer distributing capital gains on that particular account or that portfolio. The other thing, you know, one of our clients did this a couple of years ago. It just tied in perfectly. The client was looking to make gifts to their grandchildren. They had ten grandchildren. They wanted to gift $10,000 to each of their grandchildren. So they had a very tax-inefficient, very good, actively managed fund at Vanguard, and we decided that we were going to take $10,000 and transfer it over to each of the grandchildren. So that got that $10,000 out of their account and we did it right before the December distributions. So that’s a good time, you know, to do that in November. We’re sitting here at November 17 today. So perfect time to do that so that that client was not actually exposed to the capital gain distributions. On the flip side, I think one of the more underutilized strategies today is the grandchildren. Most of them were actually either not working, had no income, or very little income. So they were in the lowest 15% marginal tax bracket. They can turn around and sell those investments at a 0% capital gain rate in the 15% marginal tax bracket. So you don’t see that. Joel, I don’t think you see that too much, but that gets, I think, overlooked. And then the last, I think, strategy that we would talk to our clients about, which is a very popular strategy, especially this time of year, is tax-loss harvesting. And that’s essentially a process where you’re matching your gains to your losses trying to really, as a tax reduction strategy, trying to mitigate your taxes for the given current year and possibly even in future years.

Important information All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss. This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation. It is possible that funds will not meet their objective of being tax-efficient. © 2016 The Vanguard Group, Inc. All rights reserved.