In a world full of financial uncertainties, tax-sensitivity is one aspect of investing that you can control. At Whittier Trust, we have been laser-focused on after-tax returns—the dollars you keep—since the early 1980s. That focus has become a key differentiator and one of the many reasons clients tend to stay with Whittier from one generation to the next.
Most of the investment industry continues to focus on pre-tax returns, an approach that is woefully inadequate for taxable investors, especially in locations that combine state taxes with Federal tax rates to tax portfolio returns at 50% or more.
We’ve found that there are four elements that allow investors to unlock superior after-tax returns: asset location, time horizon, structure, and a total return approach for income generation. Here’s why.
Asset Location
The first key to consider is asset location. Not to be confused with asset allocation, asset location is the most impactful tactic in maximizing after-tax returns. Assets that are tax-inefficient, such as corporate bonds, private debt, or high turnover strategies, should be placed in tax-deferred accounts where they can generate high returns while compounding tax-free. On the other hand, assets that are tax-efficient, such as high-quality low-turnover stocks, low-dividend equities with long-term growth opportunities, and tax-favored bonds like municipal bonds or preferreds should be held in taxable investment accounts where compounding can still occur tax-efficiently. For our clients, the Whittier team is laser-focused on maintaining the optimal mix of assets and the right asset locations to maximize ROI.
Time Horizon
The second key is the time horizon. Patience is a tax saver. The longer assets are held, the greater the ability to compound returns with minimal tax friction. It is important to let time be your ally. One of the easiest time horizon tax enhancements is to factor in the difference between short-term and long-term capital gains. Over long-term time horizons, the difference between a tax-sensitive investment management style and a tax-agnostic style is stunning. Patient, long-term investors can generate significantly higher after-tax returns than impatient short-term investors without regard to taxes. Having an advisor and portfolio manager who advocates this approach can help temper knee-jerk reactions to market fluctuations and help encourage patience along the way.
Structure
The third key is structure. Structure pertains not only to the entity the investment is formed in but also the structure of the investment itself. A few key items to consider are whether the entity is an LLC, a Limited Partnership, or a Trust that owns the asset, or whether the asset itself is taxable as ordinary income. The investment may have tax benefits from the structure such as depreciation offsets or preferred returns rather than phantom income. The structure of the investment can be the difference maker when taxes are due. Having tax specialists and attorneys as part of our team at Whittier is key, as we’re always optimizing our clients’ structure in light of changing laws and regulations.
Total Return Approach
Finally, using a Total Return Approach to enhance after-tax wealth. Generating income in a tax-efficient manner will allow for sustainable withdrawals of the portfolio while it continues to grow after taxes and inflation. The adage that more wealth has been lost chasing yield than at a barrel of a gun, holds even more true today than ever before. Legendary investor Warren Buffet never paid a dividend from Berkshire Hathaway, yet the compounding of the company’s stock has more than covered the lifestyle of his early investors. The market has many investments with yields that seem enticing but are not commensurate with the risk incurred. Remember that some companies pay out significant dividends because they have no better reinvestment opportunities.
In today’s world where every dollar retained counts, embracing a tax-conscious strategy becomes essential for building a resilient and prosperous investment portfolio.
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Written by Caleb Silsby, Executive Vice President, Chief Portfolio Manager at Whittier Trust. To learn more about maximizing after-tax returns, start a conversation with a Whittier Trust advisor today by visiting our contact page.
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