Why Taxes Matter To Your Investments | Erik Averill, Brandon Averill | AWM Insights #19
Episode Notes
One of the most important distinctions we like to make with our clients is that our primary job is not only investing. We re-center our clients’ definition of success by asking them if simply investing is the goal or if it’s actually to increase their net-worth after taxes and expenses?
The answer is always: net worth.
Investing is really just a means to an end. Our primary job, and the ultimate value we deliver, is in increasing our clients’ entire net worth.
Unfortunately, the act of investing is typically the sole focus of retail financial advice. The average broker and financial advisor will spin their wheels trying to sell their investment strategies in the public markets, yet this is rarely the main driver of wealth. Most investors miss out on other financial moves to grow and keep wealth including tax planning strategies that can produce double digit returns on their net worth.
This week, Erik and Brandon discuss some of these strategies and why they should be important to you covering topics like:
Why should I consider taxes in my investment conversations?
Why aren’t more financial advisors talking about this integration of investing and tax planning?
What are conversations I should have with my financial advisor to keep the returns from taxes that I deserve?
What are some other ways to manage, defer, and reduce taxes when it comes to your investment plan?
Are there ways a 1099 employee can reduce taxes?
Why those in the highest tax bracket might want to consider asset location and tax-loss harvesting in their tax strategy plan
+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to another episode of AWM Insights, where we cover all things investing. We are excited to jump in to a conversation about taxes. Brandon, it's July 14th. Are you excited?
Brandon Averill (00:14):
Oh, I'm pumped. When Tax Day is right around the corner, it's always a good day, right?
Erik Averill (00:18):
Oh, always a good day. Now for a lot of our audience listening, they may actually be unaware. So because it's 2020, the strangest year ever, the government has actually extended the tax filing deadline to July 15th. And so, for a lot of individuals, they have, of course, waited until the day before. But the reason we want to talk about taxes today is, for us it's not just a focus on investing, it's actually a focus on net worth. And Brandon, can you give our audience a little insight into why we're even talking about taxes on an investing podcast?
Brandon Averill (00:54):
Yeah, definitely. I mean, taxes at the end of the day affect everything. Nobody, that I've talked to at least, gets fired up about paying taxes, but they are a reality. And so when we're making decisions, whether they're financial planning decisions or certainly investment decisions, we need to be taking taxes into account. So while 7/15 isn't a day that anybody really looks forward to, it is a welcome break for us to take our mind off the short-term impacts that we're seeing as we try to figure out what's happening with COVID and turn our attention to something that we can control and helps us to make better outcomes for our investing decisions.
Erik Averill (01:32):
And really what we talk a lot about is taxes is not something that happens once a year. Really this is forward-looking, this is tax planning, because the focus is on net worth. It's really, when we think about investing, it's a means to an end. It's an opportunity to hopefully grow our wealth. But what we as investors and people really care about is the net returns, the amount of money that hits our pocket. And it's interesting, Morningstar had published an article that, from an investment return standpoint, taxes really accounts for a 2% annual drag, which is very dramatic when it comes to your investment returns. Brandon, what are some of the things that investors can do to minimize the tax bite when it comes to investing?
Brandon Averill (02:20):
Yeah, I think the biggest thing is understanding your situation. If you're in the highest tax bracket, we've covered them on previous podcasts, but make sure that your portfolios are utilizing what's called asset location. If you've got an account that is a taxable account and then you have some retirement accounts, you certainly can take advantage of this. For people also that are able to save money outside of retirement accounts, there's a practice called tax-loss harvesting.
Brandon Averill (02:47):
So those are just two quick examples that you can focus on. But I think it's really just looking through the lens of, "How is this going to impact me from a tax perspective? Does it generate income? And if it does, is that income after taxes justified for the investment." It's really a mindset. It's a practice of looking at your investment decisions with taxes in mind.
Erik Averill (03:11):
Yeah. And I think one of the things to point out for the audience is, it's curious, you might ask the question of why are more financial advisors not talking about this integrated tax planning? And it's because 85% of Americans actually are in a tax bracket that is lower than 20%. And so for a large part of people, it's irrelevant. But for the majority of our listeners and clients who are in the highest tax bracket, this is significant. It's something that we say, "Taxes are most likely the biggest expense that you're going to pay. I mean, if you're in the highest tax bracket, that's 37%, you add on the net investment income surtax of another 3.8%, you add on state tax, we're talking to 40 to 50% of every dollar is getting eaten away at taxes. And so it's interesting that there's such a focus in the investment world that we're combating right on this podcast, a lot of the day trading or the hot stock tip.
Erik Averill (04:12):
And with all of that effort, to put it into context, since 1990, the S&P 500, which has seen a year in which it was down 53%, right? There's a lot of uncertainty and what is perceived risk around it. That's to go get an annualized return of 9.7%, which that's nothing to balk at, a 9.7% return annualized, your money's going to grow kind of every seven to 10 years. That's a great thing. But what we're talking about here is, what if we could say, "There's a way to lock in 40 to 50% returns on your money just through being proactive in planning"? And so, Brandon, maybe talk a little bit about some of the retirement planning that is beyond the employer 401k. What happens if you've got 1099 income? What are some other ways to reduce taxes when it comes to integrating with your investment plan?
Brandon Averill (05:08):
Yeah, that's a great point, Erik. There are, as you mentioned, accounts that can significantly benefit you. So if you are an independent contractor, you are receiving income aside from employer income, you're able to set up accounts such as an individual 401k or a SEP-IRA. And those accounts become very powerful in deferring income taxes down the road. So it's really an understanding of your situation. I think the other hard part about this is there is no one size fits all. It's really leaning on your advisors to understand what's happening with taxes, your overall situation, managing what you might need from a cashflow perspective to what you're able to save for a longterm. So it's a complicated puzzle, but it's an important puzzle, as you mentioned.
Brandon Averill (05:55):
And if you're in the highest tax bracket, this is something you should pay attention to. A lot of people will just blank it out. "Hey, maybe I'll get some municipal bonds because I don't want to pay the state income tax." Well, that's generally a good idea, but there are cases, which partially we're going through right now, where there needs to be an evaluation. Paying taxes isn't always the worst thing. You need to evaluate the after-tax return. A taxable investment may have a better after-tax return than a tax-free investment when you take risk into account. So all this stuff we're talking about, I just encourage you guys to get with your advisors, make sure that they're taking the tax situation into account and they really have a good understanding of it. And then you'll participate in these benefits.
Erik Averill (06:41):
You make some great points right there that, ultimately, we talk about this a lot on this podcast, is we want everybody listening to this to capture the returns that they deserve and that's after tax. And unfortunately, you'll even see some marketing gimmicks or things from online platforms that talk about just an algorithm doing everything. When it comes to the customization and personalization of your investment plan, there's no one model that's going to do this perfectly. It needs to be very specific to your situation.
Erik Averill (07:14):
And I just encourage you, as Brandon said, is you should be able to reach out to your certified private wealth advisor. And the question you need to ask them is where's the detailed plan on being able to manage taxes, defer taxes, and reduced taxes? Those are the three pillars of a integrated tax planning strategy that every investor should have. And so it's one of those things that we make sure is integrated with every single client, because at the end of the day, it's we want you to capture that return that you deserve.
Erik Averill (07:45):
And so until next time, if you guys want some more information about just the integrated tax planning we're talking about, head over to AWM Insights. You'll be able to see the show notes here. We'll put some links in for some resources that will be helpful on that. And until next time, stay humble, stay hungry, and always be a pro.
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