Traditionally, investment managers have paid scant attention to the tax ramifications of their strategies on clients. There has also been a general lack of demand from clients for tax-managed strategies, but this is now changing as taxable investors are realizing the importance of maximizing after-tax returns. One manager that has been ahead of the curve in the research, development and implantation of tax-managed strategies is Dimensional Fund Advisors, a Santa Monica-based mutual fund manager, whose tax-managed funds have been remarkably tax efficient.
Menlo Park, CA (PRWEB) September 13, 2004 -- "Traditionally, investment managers have paid scant attention to the tax ramifications of their strategies on clients," says Dan Goldie, a financial advisor to wealthy individuals and families in Menlo Park, CA.
In a mutual fund prospectus, for example, one will typically find objectives such as maximize returns," rather than maximize after-tax returns." Attempting to maximize returns, investment managers may engage in behavior—such as excessive trading, inappropriate emphasis on high yielding securities, or reluctance to harvest losses—which reduces after-tax returns (as well as pre-tax returns in many cases).
"I believe there are many reasons why the investment industry evolved with a lack of sensitivity for the tax needs of clients," continues Mr. Goldie. "One reason is simply that most money under management is tax-deferred, invested by pension plans, endowment funds and charitable organizations, and would not benefit from tax-management. Another is the general lack of knowledge in the investment community of how to manage assets tax-efficiently. There has also been a lack of demand from clients for tax-managed strategies, but this is now changing as taxable investors are realizing the importance of maximizing after-tax returns." Mr. Goldie says that he sees increased tax sensitivity among his clients.
One manager that has been ahead of the curve in the research, development and implementation of tax-managed strategies is Dimensional Fund Advisors. In the late 1990s Dimensional turned its research efforts toward the development of tax-managed strategies to benefit its significant base of taxable shareholders, the clients of independent investment advisors such as Mr Goldie.
According to Mr. Goldie, "Although structured strategies like Dimensionals standard funds are inherently tax-efficient, certain asset classes, such as small cap and value, are less tax-efficient than total market or market neutral asset classes. This is because stocks migrate in and out of these asset classes, sometimes rather quickly, causing turnover and possible capital gain recognition. For example, a small-cap portfolio must sell small companies that grow larger than size boundaries, usually at a gain, to maintain its asset class integrity."
Mr. Goldie continues, "Interestingly, it is the higher-expected-return asset classes that are the least tax-efficient. Including them in portfolios is valuable, and having the ability to invest tax-efficiently in these asset classes is a big benefit for taxable investors."
Four of Dimensionals five tax-managed portfolios went live in 1999, giving a five-year track record with which to evaluate their success. The ability of the funds to minimize returns lost to taxes has been significant. In fact, none of Dimensionals tax-managed funds has made a capital gain distribution since inception. Although this will not continue indefinitely, the only tax cost to date is from dividend distributions, which can not be avoided.
Here are the essential elements of Dimensionals tax-management strategies:
Avoid Short-Term Capital Gains. Because short-term capital gains (securities held one year or less) are currently taxed at a significantly higher rate than long-term capital gains (securities held longer than one year), Dimensional will hold stocks until they qualify for long-term gain treatment.
Harvest Losses. Continuously during the year, Dimensional looks for opportunities to sell stocks at a loss, looking to buy them back after 31 days to avoid wash-sale rules, but only when such a transaction yields expected tax benefits that are at least 8 to 10 times the cost of the trade.
Monitor Dividends. Holding securities whose dividends are qualified" under the tax code significantly reduces taxes for investors. For dividends to be qualified, the issuing company must meet specific criteria and Dimensional must satisfy certain holding requirements with the stock. Dimensional also engages in dividend minimization strategies, although this is rarely done today due to low dividend tax rates.
Carry Forward Losses. The use of tax-lot accounting allows the accumulation of losses that can be carried forward to offset gains in future years. Recently, the down market of 2000-2002 created an opportunity for the funds to compile significant accounting losses.
Dan Goldie is a financial advisor to wealthy indvidials and families. He is located in Menlo Park, California. Investment Advisory services provided through Partnervest Advisory Services LLC.
FOR FURTHER INFORMATION CONTACT:
Dan Goldie
750 Menlo Avenue, Suite 200
Menlo Park, CA 94025
650-326-9879
http://www.dangoldie.com
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