Turmoil, Taxes, and Time – In times of volatility is tax management the new hedge?

Avatar photo by Hiren B. Patel, Head of Advisor Solutions

There is little doubt we are living in turbulent times. A two-year global pandemic has led to supply chain issues that have created macro-economic disruption, impacting everything from computer chips to baby formula. While skyrocketing gas prices are dominating the headlines and the coffee-shop talk, inflation isn’t just hitting the pumps, it is being felt across every industry. Add to that Geo-political turmoil and extreme partisanship dominating the domestic agenda, and it’s easy to see the impact these events are having on the markets. 

As an advisor today, you are facing severe headwinds that make it difficult to manage your business and convince your clients to remain calm and stay committed to the financial plan you have built together.

To add additional confusion in the markets, traditional hedges built within a client’s portfolio have not been as effective in recent months.

Modern Portfolio Theory and diversification of assets acting as a hedge has simply not held up in this market environment:

  • Equity markets have seen a Max Drawdown of 15.5% over the first four months of 2022.
  • Inflation rates have become top of mind for the Federal Reserve and will impact the bond market with interest rates rising and expected to continue. These rising rates may not be protecting a client’s portfolio against the Equity Markets as a hedge, instead it may be contributing to client’s losses.
  • Concurrently, a hedge against the domestic equities market to find growth opportunities, international markets has also faired negatively over the course of 2022.

Drawdown S&P 2022

Often times with clients skittish of the markets, moving towards cash is a prevalent strategy in times of volatility.

The question begs, how do you as an Advisor provide easing and a strategy to navigate through these times?

Clients during volatile markets are looking for advisors to focus on more than their portfolios and evaluate complex trading scenarios and systematically combat volatility. They are also looking for a professional, a coach, a therapist, to manage their emotions through the volatility.

One area that can be considered is tax management. Taxes aren’t stand-alone issues. They are in fact very much a part of the investment decision-making process. Many times, even withdrawals are taken into consideration through the lens of taxes or clients are setting aside assets to cash in order to pre-pay or plan ahead for unanticipated tax expenses.

Even more so when tax loss harvesting strategies are deployed by financial advisors, those strategies are mainly built around individual equities, as well as Equity ETFs and Mutual Funds, presenting themselves for tax loss harvesting opportunities. Many advisors may not consider where opportunities may arise in the form of tax loss harvesting with fixed income or commodity focused mutual funds and ETFs. Often times, it could be seen as oversight, as very rarely will tax loss harvesting present itself in these areas.

Timing the market has never been a viable option. However, a systematic approach to generating tax loss harvesting value has proven to be a consistent way to generate alpha. Tax loss harvesting contributes value to their portfolio as an additional component to an overall strategy while still staying invested in the markets. And 55ip’s, systematic monthly tax loss harvesting over the last four months has been instrumental, specifically, as a key to presenting after tax returns to your clients

Recent tax loss Harvesting activity has presented opportunities to advisors and their clients that are utilizing this strategy:

In 2020, the market volatility resulted in a steep tax loss harvesting opportunity within a short two-month window. However, to avoid wash sale implications this may have resulted in only two to three harvesting opportunities.

Drawdown S&P 2019-2022

However, year to date we have experienced four consecutive months of market volatility nearly doubling the number of harvesting events while abiding by Wash Sale rules2.

  • January: 55ip managed to trade in 54% of our managed taxable accounts for a sampling of assets. Those trades within our sample set spanned across 105 unique securities for a total of 13,010 trades for the month of January. The nominal loss 55ip was able to capture was 1.12% in our sample data.
  • February: 55ip managed to trade in 59% of our managed taxable accounts for a sampling of assets. Those trades within our sample set spanned across 110 unique securities for a total of 10,746 trades for the month of February. The nominal loss 55ip was able to capture was 0.40% in our sample data.
  • March: 55ip managed to trade in 24% of our managed taxable accounts for a sampling of assets. Those trades within our sample set spanned across 79 unique securities for a total of 4,739 trades for the month of March. The nominal loss 55ip was able to capture was 0.85% in our sample data.
  • April: 55ip managed to trade in 53% of our managed taxable accounts for a sampling of assets. Those trades within our sample set spanned across 99 unique securities for a total of 11,371 trades for the month of April. The nominal loss 55ip was able to capture was 1.08% in our sample data.

In all, 55ip benefited advisors by systematically completing trading capabilities, tax loss harvesting events, navigating wash sale rules, managing proxy securities, and generating client reporting.

In total, 55ip managed to trade in 62% of our managed taxable accounts for the collective sampling size. During this period of volatility, 82% of AUM in our sample was impacted by a trade from the collective accounts through April. The losses harvested within our sample set spanned across 135 securities resulting in 40,969 total trades in the span of four months. These results have generated a nominal loss of 2.32% from this sample group.

Over time, 55ip sets out to provide a strategy and sense of relief to advisors and their clients when trying to manage the reduction of concentrated positions or unmanaged to managed assets while avoiding realizing capital gains beyond the client’s comfort.

Turmoil, Taxes, Time, AND 55ip

If you are a client of 55ip, speak to your Advisor Success Manager to review your clients to ensure that you have identified those accounts that you feel would be best suited to this approach. If you are not a client of 55ip, please contact our team at info@55-ip.com to see a demonstration and consider if this approach is right for your business.

Footnotes

1 ICI: Experiences of US Money Market Funds During the COVID-19 Crisis

2 Wash sale rules do not allow an investor to realize a capital loss for tax purposes and purchase a “substantially identical” security within 31 days of the realization of the capital loss. For reference see IRS Publication 550.

Past performance does not guarantee or indicate future results and there can be no assurance that any investor will achieve comparable results or that any return objectives will be met. No representation is made that any investor will, or is likely to, achieve results comparable to those shown. All investments involve risk, including loss of principal. 

The impact of a tax-loss harvesting strategy depends upon a variety of conditions, including the actual gains and losses incurred on holdings and future tax rates. The results shown in these materials are illustrative and do not represent actual investment decisions.

The tax-loss harvesting service is available for an additional advisory fee and the results shown represent the net effect of the advisory fees but may not consider the impact of fees charged by others, including transaction costs or other brokerage fees. The information contained herein is subject to change without notice, is not complete and does not contain certain material information about the investment strategy, including additional important disclosures and risk factors associated with such investment and information about fees, trading costs and taxes. Neither the U.S. Securities and Exchange Commission nor any state securities administrator has approved or disapproved, passed on, or endorsed, the merits of this document. More information at www.55-ip.com.

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