with a Tax-Management Focus
It goes without saying that 2022 was a volatile year for investors. The rapidly swinging momentum of the markets, high inflation, and continued impacts of the COVID economy provided quite a ride for anyone following the major stock market indices. Even many bond funds were down by more than double digits during 2022.
There are plenty of excellent recaps and analyses of the broad strokes of 2022’s investment markets, so I won’t repeat them here. Instead, I want to share what 2022 looked like for investors and advisors who applied a tax-smart approach to their investment strategies – and how those strategies might affect taxes owed from 2022 while setting them up for a tax-smart 2023.
In a volatile year like 2022, it was especially important to apply a tax-loss harvesting strategy, selling assets when they have an adjusted cost basis lower than their purchase price and immediately repurchasing higher conviction and/or similar (but substantially different) assets with the proceeds. Recognizing the loss creates a tax asset that can be applied to reduce an investor’s tax burden in a few ways.
At Frontier Asset Management, we had plenty of opportunities to apply active tax-loss harvesting trades, and it made a measurable difference for investors. To be clear, our goal is maximize after-tax return, so we don’t seek to invest in declining assets, but when a fund or ETF falls into loss territory and meets other criteria – as can happen with any long-term asset when market conditions are right – we look to take advantage of the afforded opportunity.
Tax-loss harvesting 2022: How we saved 2% on average taxes
With investor 1099’s being mailed out in January and February, investors need to remember it’s not just capital gains distributions but also losses that have been harvested for the tax bill.
In 2022, Frontier Asset Management initiated tax-loss harvesting trades that – on average – created tax savings for investors of approximately 2% of the strategy return. For the average investor, these harvested losses were enough to offset the taxes related to income and capital gain distributions. In fact, these harvested losses were in – on average – in excess of distributions by about 2% of the strategy’s market value. These harvested losses can be applied to other gains for the year if applied immediately or could be used to offset future gains in subsequent years. (By rule, these losses can be used to offset taxable capital gains, deducted from an individual’s taxable income up to $3,000, or carried forward into a future year. As a result, a given investor’s result may vary depending on how the loss was used.)
When you get into specific scenarios, you see results in greater detail. For an investor in our Tax-Managed Balanced Strategy through a third-party investment platform, we calculate this loss harvesting could have translated into approximately 6.5% of losses as a percent of strategy market value harvested throughout 2022. A hypothetical investor with $100,000 in our Balanced Strategy would have, on average, realized $6,500 of losses harvested on their behalf. (See footnotes for assumptions used in this calculation.)
It’s worth noting that this is another area where our approach differs from that of many firms that offer tax-loss harvesting: We harvest the losses on a specific investor’s fund or ETF for that investor, who can then apply that harvested loss when and how they choose. This is similar in approach and appeal of direct indexing. Many tax-managed mutual funds pool the realized losses within the fund and use them to the advantage of the mutual fund overall – which is still a benefit to investors, but what happens when harvested losses are greater than income? Instead of the investor owning the harvested loss, the mutual fund will carry the loss forward into future years – not the investor.
What I Mean by Tax-Smart Strategies
Being tax-smart includes many different techniques and approaches. And the goal is not always the same. Some approaches look to minimize distributions and the related investment taxes. The overriding goal appears to be low taxes. Other approaches look to maximize after-wealth – even if that means incurring taxes along the way. The two goals are often in conflict with each other.
Paying no taxes is great – but if incurring a little bit of tax offered a higher after-tax return and led to higher after-tax wealth – more money in your pocket after-tax – we see that as the objective. This is the focus at Frontier Asset Management, where we believe a little extra effort and independent thinking can pay off. We believe you should pay the taxes required to get the best after-tax return, and no more.
A few other things to consider in our tax-smart approach. We use tax loss harvesting as an opportunity to refine the mix of our strategies to help manage the overall risk. This helps to ensure we have the highest confidence line-up across our strategies. It is not a case of letting the tax tail wag the dog, and we have open architecture approach that allows us to consider virtually every active or passive fund and/or ETF. Not being limited to proprietary funds is important.
For over 22 years, we have found success for our clients by taking a different approach to investing, which also applies to our tax-managed strategies. If you’d like to learn more about how our independent, results-focused approach can help you stand out as an advisor and benefit your clients, talk to us today.
- Assumes holding period of 10 years or less if a fund has shorter holding period.
- Does not account for other taxable trades across investors portfolio.
- Accounts for only trades initiated for tax-loss harvesting.
- Assumes the maximum Federal tax rates are applied to harvested losses.
- Actual results may vary.
Important Disclosure Information
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice.
Frontier Asset Management LLC is a Registered Investment Adviser. The firm’s ADV Brochure and Form CRS are available at no charge by request at email@example.com or 307.673.5675 and are available on our website www.frontierasset.com. They include important disclosures and should be read carefully.