Pursuing long-term growth is important for most individuals and families with substantial taxable portfolios, but they should keep after-tax outcomes in mind. Capital gain taxes can take a significant portion out of investment returns, making tax-aware strategies not just beneficial but vital to helping preserve and compound wealth.
Traditional portfolios often focus on pre-tax performance and neglect the cumulative effect of taxes over time. The oversight can cost millions of dollars in lost opportunity for investors with complex financial lives and significant exposure to taxable assets. Professionals at Forvis Mazars seek to prioritize after-tax results, integrating strategies designed to help reduce tax drag while maintaining market exposure and growth potential.
This article will explore some of the most effective tools we’ve observed, including direct indexing and long/short separately managed accounts, commonly referred to as SMAs.
What Is Direct Indexing & How Does It Work?
With direct indexing, one may own individual stocks to replicate the broad market index instead of buying shares of an index fund or exchange-traded fund. This option allows owners to have precise control over each security in the portfolio and enables tax-loss harvesting at the individual stock level.
When certain stocks within the index decline in value, they can be sold to realize a capital loss while maintaining overall market exposure by purchasing similar securities. These harvested losses can be used to offset capital gains elsewhere in the portfolio and, importantly, outside the portfolio as well. Over time this tax alpha, or gains achieved through tax efficiency, can compound meaningfully, especially in volatile markets where loss harvesting opportunities are more prevalent.
Direct indexing also offers customization opportunities, such as excluding specific sectors, aligning holdings with personal values, or integrating legacy positions. For investors with significant taxable wealth, this can provide a flexible and powerful way to stay invested while actively managing tax exposure.
What Are Long/Short SMAs & How Do They Work?
Long/short SMAs are actively managed strategies that combine long positions in stocks expected to outperform with short positions in stocks expected to underperform. The primary objective is to enhance portfolio performance through disciplined stock selection and active management.
The short positions serve a dual purpose. First, they aim to generate incremental value within the portfolio by targeting underperforming stocks. Second, some of these positions will produce capital losses over time, which can be harvested and used to offset gains. Although tax-loss generation is a valuable byproduct, the strategy is fundamentally designed to improve return potential. This combination of potential performance enhancement and built-in tax efficiency makes long/short SMAs a compelling option for investors focused on enhancing after-tax outcomes without sacrificing growth.
Why Tax-Aware Strategies Matter
The cumulative effect of tax-loss harvesting is powerful. Investors can potentially boost compounding and improve long-term outcomes by deferring gains and reinvesting tax savings. In addition, they can apply losses generated through these strategies to the gains within the investment portfolio, as well as external sources, such as business transactions, real estate sales, or concentrated equity divestitures. Due to this versatility, tax-aware strategies are an essential tool for managing overall tax exposure. Over time, this can lead to a material difference in wealth preservation and growth, especially when paired with thoughtful estate planning and philanthropic strategies.
How We Can Help
In summary, tax-aware investing is not a niche consideration. It is a cornerstone of intelligent portfolio management for those with significant taxable wealth. If you are interested in learning more about our thoughts on how to best design portfolios for after-tax results, please contact your nearest Forvis Mazars Private Client representative.
Forvis Mazars Private Client services may include investment advisory services provided by Forvis Mazars Wealth Advisors, LLC, an SEC-registered investment adviser, and/or accounting, tax, and related solutions provided by Forvis Mazars, LLP. The information contained herein should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned herein, may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.