Taxes and Investments

Sandra Testani at American Century has a useful summary of ways for people to reduce their tax burdens of their investments. She cites three strategies to do so: tax loss harvesting, distribution management, and investment planning.

Tax loss harvesting means using investment losses to offset capital gains so as to reduce tax burdens. Besides canceling out investment gains, up to $3,000 in tax losses in a single year for joint filers can also be used to offset ordinary income, and additional losses can be carried over into ensuing tax returns. Testani advises, as do we, that tax harvesting be done within the overall context of portfolio management and client goals—in other words, tax considerations are a piece of a sell decision, but not the whole story.

Distribution management involves decisions on when to buy or sell funds. Keeping a fund at least a year means that capital gains will be considered long term in nature. Long-term capital gains receive more favorable tax treatment than short-term capital gains so there is generally an advantage to holding onto a fund for at least a year before selling it. Distribution management can also include timing purchases or sales around their dividend or capital gains distributions. While distributions can occur throughout the year, they tend to be somewhat concentrated in December, so if there’s value in either avoiding or acquiring capital gains or dividend distributions, it may be advantageous to look at buying or selling at that time. Distribution management obviously would be much more relevant for funds with relatively large distributions than for funds with small distributions.

Finally, Testani notes that portfolio construction also influences investment tax burdens. Actively managed funds have higher turnover and generate more taxable events than ETFs or index funds. Schwab’s Emily Doak observes that ETFs typically passively track an index’s performance, usually rebalancing only when the components of the underlying index changes. As such, ETFs tend to distribute fewer capital gains than do mutual funds.

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JMS Capital Group Wealth Services LLC

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An SEC‐registered investment advisor.

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument or investment strategy. This material has been prepared for informational purposes only, and is not intended to be or interpreted as a recommendation. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice.