1. Place assets optimally.
Just like your portfolio should be internationally diversified, we like to see some diversity in where your money is located, e.g. taxable, tax-deferred, and tax-free accounts. Opportunities exists to optimally locate your investment assets. For example, tax efficient assets (stocks and muni-bonds) should be held in your taxable accounts. Tax inefficient assets (real estate or taxable bonds) should be held in your tax deferred or tax-free accounts.
2. Use tax-managed mutual funds or ETFs.
As an investor, should your goal be to maximize pre-tax returns or after-tax returns? The answer is after-tax returns. Some mutual funds are not managed efficiently and at year end distribute large amounts of taxable income. In taxable accounts, we primarily use tax managed funds by Dimensional Fund Advisors who focus on the after-tax return to investors. The fund managers do this by reducing fund turnover, seeking qualified dividend income (QDI), excluding REITs, and managing cash flow.
3. Harvest tax-losses throughout the year.
Many advisors only check for loss harvesting opportunities at year-end to offset long-term capital gain distributions. We do it year-round. An investment might have a loss that could be harvested at any moment throughout the year, but might recover by year-end, wiping out the loss harvest opportunity. Word of caution for the do-it-yourselfer: be leery of wash sale rules.
If you are unsure how to see these tax avoidance strategies in your investment accounts, we’d be happy to give you a few pointers.