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Advisor Perspective

Advisor Perspective

What You Need to Know about Tax Aware Investing

Ryan Moran

Advisor, CFA, CPA, CFP®
Ryan combines his passion for the markets with an equally strong desire to help clients achieve their goals and objectives. He recognizes that his value as an advisor is found not only in results, but also in how he clearly communicates the multifaceted complexities of financial planning, investing, and taxation.

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Don’t let the tax tail wag the investment dog,” is one of many common phrases circulated across Wall Street. The meaning is “don’t let the impact of taxes determine the merits of an investment decision.” In principle this may make sense, as the tax impact of an investment is just one of many factors to consider.

However, “taxes”—ordinary income, capital gains, and Net Investment Income—are the largest expense a taxable investor pays. Rather than ignoring this significant cost, JMG focuses on minimizing the impact of taxes as much as possible. This step is often ignored by most investment managers.

As a simple example, consider an investment that pays $100 in interest each year. This interest income is taxed as ordinary income. Today, the highest tax rate on ordinary income is 37%. Interest income is also considered investment income and is assessed an additional 3.8% Net Investment Income Tax (for high income taxpayers). This interest income also faces state income tax as high as 4.95% in Illinois or 7.65% in Wisconsin. The all-in tax rate is 45.75% (Illinois) or 48.45% (Wisconsin). Of the $100 interest payment received, a taxable investor only keeps between $54.25 (Illinois) and $51.55 (Wisconsin). The rest goes towards taxes.

Remember, “It’s not what you make, it’s what you keep,” to quote another Wall Street maxim.

As many of our clients know, at the core of JMG’s investment services is the philosophy of Tax Aware Investing. By fully understanding how all the moving pieces fit together, we help our clients keep more of what they make through the integration of planning, taxes, and investing.

There are three main strategies with Tax Aware Investing: Eliminate, Defer, and Reduce.

Eliminate: tactics that result in no taxes being assessed

Defer: tactics that push the taxable event into the future to delay the payment of tax, allowing for more growth on the money that would have been paid in taxes

Reduce: tactics that recognize taxable income in years when income and marginal rates are low

In future articles, we will dive deeper into the various methods that comprise the Tax Aware Investing strategies of Eliminate, Defer, and Reduce.

Many of these tactics you have already heard from your JMG advisor (like utilizing Roth IRAs or gifting appreciated assets to charity). Other techniques we simply handle on behalf of our clients (like tax loss harvesting). Some are built into our process (like asset location and using tax efficient passive ETFs instead of active mutual funds). But across these three strategies, the focus is on what can be controlled.

While taxes cannot be controlled, we focus on optimizing each of our clients’ financial situations through a variety of techniques. Small changes, added together then compounded over time, may result in a significant improvement.

If you have questions and would like to understand how these strategies might impact your situation, please contact your JMG advisor.

Important Disclosure

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this writing, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this writing serves as the receipt of, or as a substitute for, personalized investment advice from JMG Financial Group, Ltd. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. JMG is neither a law firm nor a certified public accounting firm and no portion of the content provided in this writing should be construed as legal or accounting advice. A copy of JMG’s current written disclosure statement discussing advisory services and fees is available for review upon request.

To the extent provided in this writing, historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices. Indices are not available for direct investment.