Missing Significant Tax Savings? Pro Strategies: After-Tax Investing | Erik Averill, Brandon Averill & Justin Dyer | AWM Insights #57

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Episode Summary

Most people don't like to pay taxes and try to find every loophole there is.

But when it comes to investing, most investors are paying taxes they don't have to.

As an investor, you care about one thing, your after-tax return. Because you have one net worth, and you have one effective tax rate. And you only get to spend, grow, or give after-tax money.

Listen in as we discuss the most significant tax savings strategies that research has shown to add 2.57% of annualized returns.

 
 

Episode Highlights

  • 02:52 President Biden’s Proposed Corporate Tax Plan

  • 05:08 Why Investors Overpay in Taxes

  • 06:06 How Your Financial Advisor is Hurting Your Returns

  • 08:15 Gross Returns vs After-Tax Returns

  • 09:45 Asset Location

  • 11:09 Turnover

  • 11:54 Tax-loss Harvesting

  • 14:54 Research shows potential 2.57% of additional annualized returns

+ Read the Transcript

Erik Averill (00:00): Hey, everyone. Welcome back to another episode of AWM Insights. It's your power three, two CPWA® and a CFA. We are Erik, Brandon and Justin. And each week we aim to equip you with the knowledge and the skills that you need to invest like a pro. And each week, we remind you that at AWM, we are not loyal to Wall Street, we are loyal to you. And so we try to cut through the noise of the news and what Wall Street is selling you to bring you the information to capture the returns you deserve.

Erik Averill (00:32): And so today we're going to tackle everybody's favorite topic about taxes. But before we get into that, let's recap, what has been going on in the markets. At the forefront of the conversation around politics is President Joe Biden's proposed big, bold global corporate tax plan. Which is where we'll settle in on a lot of our conversation this afternoon.

Erik Averill (00:58): But an interesting thing from the crypto space is Credit Suisse settled a small equity trade via blockchain in a pilot test with Paxos. And I think this is a great demonstration of where the technology is showing up in real time. And how companies and infrastructure is going to change from this incredible technology. And how to think about investing outside of just cryptocurrency. And so we'll talk about that in future episodes as well.

Erik Averill (01:33): And then Wall Street showing up, doing what they do here. Being the brokers, manipulating markets. Goldman propped up the Deliveroo IPO buying 25 million, I think I got that correct, of the initial public offering. And so it's funny, Goldman, a lot of people think that this is the absolute home run of the upper echelon of working with advisors. And really, it is no different. They are just a broker, kind of lipstick on a pig type mentality. So, we'll talk about this in future podcasts. Therefore, once again, as an individual investor, trying to outguess the market's, trying to do IPO investing there is so much going on inside the markets that are out of your control, that the odds are just not in your favor.

Erik Averill (02:24): But with that, let's jump into our conversation around taxes. And why this is such an important discussion is I haven't met a person who really loves taxes. People get fired up about it. But then they actually don't implement it when it comes to their investing. And so Brandon, Justin, bring the audience up to speed for those that have not paid attention to what this corporate tax plan conversation is going on right now.

Justin Dyer (02:52): Yeah. And you said there's so much in the markets that you can't control. And so we always like to say, hey, let's focus on what we can control. And tax-aware investing is an aspect of it. We can't control tax rates, right. But we can certainly control how our portfolios may be taxed in the future. To your question, Erik, specifically, there's a couple of different aspects of it, right? There's this idea of this global corporate tax, which is really, really interesting, right? And a couple other countries or economic blocks have signaled some interest in it as well. And it could somewhat even the playing field from a corporate tax standpoint around the world. So that's one aspect of it.

Justin Dyer (03:35): Then there's also just the domestic corporate tax policy that's going on. The proposal is going from, I believe it's currently a 20% corporate tax rate up to a 28% corporate tax rate. Biden has said, "Hey, I'm potentially open to negotiating on that a little bit." And so that's kind of where we stand right now. A lot of this is jockeying for position. And where this debate will unfold from here is really, really, really hard to tell.

Brandon Averill (04:04): I think the other interesting thing is there's some desire for this global tax rate as well. A lot of the tech companies, there's all this confusion. Where am I getting taxed? What tax bill do I need to pay attention to? I think there's a lot of debate on what the tax rate actually is, but there's some widespread, I guess, appetite from the global community for something like this. So it'll be really interesting to see how it all unfolds.

Brandon Averill (04:34): But like you kind of alluded to, Erik alluded to, I think the biggest thing is I'm getting the questions from clients, "Hey, how are we dealing with this? These tax rates are coming." I mean, I had an insurance guy the other day tell me that the estate tax already changed so we got to start planning. Let's settle down for a second. Just because there's a proposal, it's not a change. But I think people get so wrapped up in these things, right? It's like, oh, this is definitely going to happen, or this is going to happen. And until it's actually in place, it's hard to say anything with certainty.

Brandon Averill (05:08): However, if you're putting a plan in place, you're really looking at taxes holistically as part of your investment philosophy, as a part of your overall financial structure, then when tax rates change, you're not sitting there trying to be so reactive and trying to figure out what to do and how to do it. It's more kind of relying back upon, you know what, I'm already planning for taxes. I'm already in the most tax sensitive, most tax aware strategies and structure I possibly can be. So much of it like Erik, you said, I mean, it comes back to the plan. Most people don't like to pay taxes. Some people really hate to pay taxes, and they'll try to find every little loophole there is. But then we'll often get a portfolio, or be reviewing something somewhere, and it's like, well shoot man, you're away half of your return to taxes every day, just because you didn't take the time to put the structure into place.

Erik Averill (06:06): And one thing I want to just help the audience orient to is why I think this is happening where most people don't think about taxes when it comes to their investment planning, is when they go to hire a financial person, they really start with the wrong starting point of what's available to me. And a lot of times it's the big brands, right? It's your Merrill, your Morgan, your UBS, your Wells Fargo, your Goldman, your RBC, your JP Morgan, right? It's Wall Street. And they've got this little disclosure at the bottom of all of their websites. We do not provide tax or legal advice. Please consult your CPA.

Erik Averill (06:48): And so what they're telling you there is all of the investment decisions in which we're doing, we're punting on your tax situation. That's because that Wall Street, they're there to show up and serve their own interests. They're there to sell you products, right? To say, hey, we have hundreds of thousands, if not millions of clients across 10, 20, 30,000 financial advisors. So we have very limited options that we're going to sell you that needs to be mass marketed. And therefore, we can't have individualized custom advice.

Erik Averill (07:25): But here's the issue. If you're coming as the investor, you care about one thing, your after-tax return. Because you have one net worth, and you have one effective tax rate. And you only get to spend, grow, or gift after tax money. And so the starting point should not be what is available on Wall Street. But if I took a step back and said, hey, what would the Rockefeller family do? What would the wealthiest people in the world do? Well, first, they would make sure that everything is individualized to their family. It's completely independent, and it's integrated because they understand the importance of after tax returns. And so I think that framework is so important of asking why all of a sudden are we talking about taxes mattering on investments? So I just want to set that framework.

Justin Dyer (08:15): Yeah. And there there's this implicit assumption, essentially what you're alluding to Erik, but there's this implicit assumption with a Wall Street advisor, investment advisor, broker, whatever you want to call it, that you're going to look at your rate of return, and you're not going to ask what's the after-tax rate of return. You're just going to look at that. You're going to see whatever that number is. Maybe it's good. Maybe it's bad. Maybe there's a dollar value attached to it. But you're not going to convert it to after tax. Once you file your taxes, let's deduct all the taxes you probably have paid because they're turning over positions and realizing short term capital gains, and et cetera, et cetera. Which I mean, if you think about that, that has the ability to shave off a significant amount of your return each and every year if you're not paying attention to it.

Justin Dyer (09:02): And you can look at a common mutual funds, as well too. Mutual funds do the same thing. Now they have to kind of by regulation. You can't report after tax returns. I mean, some platforms will do that. Bringing in some kind of assumption around tax rates, usually the highest tax bracket, et cetera, et cetera. But a mutual fund by itself, it can be incredibly tax efficient or tax inefficient. Most of them are really inefficient because the managers, they don't care about the after tax rate of return. They'll turn over the portfolio, they'll realize gains in the portfolio. And guess what? That gets distributed out to the mutual fund shareholders, and then you get taxed on it at the end of the year.

Justin Dyer (09:45): So they're going back to this concept of what you can control. What are those, right? You can control the location of your investments, whether you're holding a tax inefficient asset in a tax efficient account. So you're basically trying to shield the taxes that that inefficient tax asset would be generating. Maybe, if you can, you're holding assets that generate long-term capital gains, which right now are at the lowest tax rate. You're holding those in your taxable accounts.

Justin Dyer (10:21): The vehicles. So I mentioned mutual funds. And you can even throw ETFs into that category, right? Pay attention to how the managers of those mutual funds actually manage it. Do they have a layer of tax awareness built into it?there are mutual funds out there that, that do have specific tax aware versions of the mutual fund. And that basically means if they were going to sell, say Pepsi to buy Coca-Cola, or something like that, and they were going to realize a gain on Pepsi, they probably wouldn't do that because those two assets are really, really similar and behave very similarly in the market over the longterm. And so that's a very, very basic example of how you can be a little bit more tax aware within your portfolios.

Justin Dyer (11:09): And I alluded to turnomean, they are changing the portfolio so frequently because they don't have to report on after tax impacts of what those changes are. ver. So what is turnover? Turnover is the amount of a portfolio that changes throughout a year. And you can go see some of these huge mutual funds, and their turnover rates are through the roof. I And again, it's a huge headwind, let's put it that way, to portfolio returns and compounding returns. Whatever those gains are, get distributed to the investors at the end of the year, and detract from your rate of return.

Justin Dyer (11:54): And then the last one, I'll stop here, is tax-loss harvesting. I know we've talked about that a lot. And that's something we can control. We did it in 2020 when the COVID crash was happening, right? We can sell an asset, buy something that's very similar to maintain market exposure. But we lock in that loss on paper for tax purposes. And it's amazing to see the benefit in the future of having that loss on the paper.

Brandon Averill (12:21): Yeah. I think that's a fantastic thing to point out. I mean, I've seen it time and time again with the new clients that we've brought on over the last three months. And we're looking back in and trying to reorient the portfolio towards a more tax aware positioning. And we'll look, and see, okay, well, what kind of losses did we realize last year? And then it's like, oh, whoops. Zero. Was your guy asleep at the wheel? What in the world? Or gal. I mean, it just doesn't make any sense. I mean, if you're a long-term investor and you didn't harvest some losses last year, somebody really missed the ball. And it's a powerful...

Brandon Averill (13:00): I think we use the example before, but we have a client that, exact same market exposure, totally benefited from the run-up in markets from March of 2020. I mean, the S&P is up, what, over 56% in the last 12 months from that March downfall. He didn't miss out on any of that. He participate in the whole thing. But we actually realized over a million dollars in losses at that point. It's now allowing him to sell his home in Florida. That is going to generate a big capital gain. And it's being offset completely with that million dollar loss. So now he gets to relocate back home where he wants to be paying no tax. And all we did was do some tax loss harvesting. It didn't impact his return whatsoever. So such a powerful thing, but it gets missed so often.

Brandon Averill (13:51): I think it goes back Erik, to your point, it's just not the thing that's taught to the brokers, right? It's just these types of strategies, these types of thoughts, don't even cross their mind. I can only imagine having started our career at one of the wirehouses and watching the flash crash. And I can only imagine what was happening when we're going through the COVID crash. I mean, it's probably buy this, sell this. We're going to time this, that. And I know we're going to get into this in a future episode, but not trying to out guess the markets. I mean, I think David Booth from Dimensional Fund Advisors have made the comment in a recent article, but if you've actually stayed in the market from March 2020 of last year till now, I think it's probably time for a victory lap. Because you did what you're supposed to do as a long-term investor. You stuck to that plan. You controlled what you could control, and ultimately that's what leads to good investment experiences.

Erik Averill (14:54): Yeah. And Brandon, I think you shared a few things to emphasize. Number one, to put a bow on what Justin talked about, about the return impact on your portfolio. When putting in tax loss harvesting, tax-efficient withdraw, asset location, rebalancing, all these things we're talking about Morningstar and Vanguard and Betterment have done these research reports. You add about 2.57% of annualized return. And so where most of the brokers are sitting there selling you some vanity play, right? That we can get you this gross return, and we're going to be active in the market and we're going to outguess it. Not only are they going to underperform, which we talked about last week, but they're going to cost you more money in taxes because they're generating taxable advance. Same thing in the crypto space, right? There are taxable advance.

Erik Averill (15:53): And so I think just once again, the difference between an amateur and a pro when it comes to investing is understanding your number one priority is after tax returns. And if you are working with someone who does not pay attention to that, it's an amateur move. And so it's a bold statement to say this, but if you work with a broker on Wall Street, you're getting amateur advice that is costing you money. And so, hey, here's the good news. Guess what? There are over, I think, it's over 2,000 independent registered investment advisors that can put your interest at the forefront. And then you can hire a bunch of people like us that are CFAs and CPWAs and have integrated tax planning. Because that's what matters.

Erik Averill (16:44): And one piece of advice that we completely missed on is when it comes to taxes, California, hey, you are now second best. The state of New York really did one in. And now a individual who's a resident of the state of New York is paying between 9.65% and 10.3. So for a combined tax rate of 52%. So shout out to New York. Became even more expensive, but this lays out why it's so important to have an integrated, coordinated plan, right? That what we're saying is, it's not that investments don't matter. It's investments plus structure is the definition of success.

Justin Dyer (17:36): Oh, there's no doubt about that. And we didn't even get into estate planning as part of this conversation. We talked a lot about investments. But that's really exactly what you're alluding to Erik. But the estate tax, proper estate plan, and structure on that side, integrating that with your investments, your investment accounts, where you're holding assets, the title of what those assets may or may not be, and doing it based on what is known, the existing playing field, right? Don't try and out guess what might be happening in the next administration, or what what's even potentially coming from the Biden administration right now, right? Like I said, there's so much jockeying going on right now. Are things going to change? Probably. But trying to plan right now, based on some assumption, I mean, you could really cost yourself in that way as well.

Erik Averill (18:30): Yeah. And just as we get ready to close out, there's a few low hanging fruit things that you can open up your investment accounts and see if there's any real tax planning going on. So first and foremost, depending on what your effective tax rate is, which changes every single year, you should have some type of retirement accounts in your statement. So we just saw this, we brought on a new client. And unfortunately for this family, he's been invested for literally 15 years. No type of retirement accounts. So he's got some 1099 income, no individual 401(k), no backdoor Roth IRA, nothing.

Erik Averill (19:17): And this is heartbreaking because we're talking about getting money into accounts that are either tax deferred or tax-free. And so if you open up your account, especially if you are in the highest tax bracket, which so many of you guys are that are listening, you better have an individual 401(k), you better have a backdoor Roth IRA strategy going on.

Erik Averill (19:40): And then for so many of you here that are involved in the private space, in venture, private, real estate, do you have self-directed IRAs? Do you have individual 401(k)s that you are holding some of these private assets in. Because that could absolutely juice your ability to have multi-generational wealth. And so all of this is going to be in the show notes. Head over to awminsights.com. You can access it. And then once again, we said last week, we're offering to everybody, it's the 10 Keys to Investing Like a Pro. Justin, Brandon, and I've talked about a few of those already today. Taxes matter, control what you can control. Next week, we're going to talk about outguessing the markets. But until next time, stay humble, stay hungry, and always be a pro.

 
AWM InsightsAWM CapitalJustin Dyer, Erik Averill