Displaying items by tag: capital gains tax

Hedge fund billionaire John Paulson, known for his profitable bet against the housing market during the financial crisis, warned of a potential market collapse if Vice President Kamala Harris' proposed tax plans are implemented. 

In an interview on CNBC, Paulson criticized Harris' endorsement of raising the corporate tax rate to 28%, increasing the capital gains tax to 39%, and taxing unrealized gains, predicting these measures would trigger a financial downturn. While Harris has supported tax hikes proposed by President Biden, insiders suggest she may not pursue taxing unrealized gains. 

Paulson believes such policies would lead to massive asset sell-offs and a recession. Some economists agree higher corporate taxes could impact earnings but don't foresee the drastic crash Paulson predicts. 

Finsum: The impacts of the taxes on unrealized capital gains are overblown, they affect a very small unmeasurable margin.

Direct indexing has many advantages, such as lower costs, boosting after-tax returns, and providing more flexibility to clients. However, some advisors are failing to properly implement the strategy, which means some portion of the benefits are not being realized. 

According to Barret Ayers, the CEO of Adhesion Wealth, advisors should offer direct indexing through unified managed account (UMA) frameworks. Currently, only 2% of direct indexing assets are managed through UMAs, with the majority in separately managed accounts (SMAs) or as a standalone model.

By going through a UMA, tax-loss harvesting strategies can be fully implemented and optimized. With standalone accounts, or SMAs, it’s burdensome to manage rotations out of losing positions or transfer holdings when necessary. As a result, many losses cannot be captured due to penalties or restrictions on wash sales. 

Another benefit of direct indexing through a UMA is that advisors can most effectively leverage core-satellite strategies to build a portfolio. This entails a core portfolio allocated to indexing with smaller pockets of higher-risk, higher-return investments in inefficient asset classes. Within a UMA, this strategy's efficacy can be maximized as it allows for efficient rebalancing, changes in asset allocation, and reduced time spent on administration.

Finsum: While direct indexing is surging in popularity, many clients and advisors are failing to fully take advantage of its benefits. Here’s why direct indexing in a UMA is the best approach.

A feature of separately managed accounts (SMAs) is that investors directly own securities, compared to an ETF or mutual fund. This makes them more tax-efficient, as investors have more opportunities to harvest tax losses and capitalize on volatility. In contrast, mutual funds, or ETFs, offer much more limited opportunities.  

With SMAs, tax losses can be harvested even in years with positive returns, as securities that are down can be sold. These losses can be used to offset gains and reduce an investor's overall tax bill. Positions can be rebought after 30 days to avoid wash sale restrictions, or stocks with similar factor scores can be purchased instead. 

Unlike mutual funds, SMAs are not subject to embedded capital gains. Embedded capital gains mean that an owner of a mutual fund is liable for capital gains depending on a position’s cost basis. This means that an investor in a mutual fund could be liable for capital gains, even if they have a loss on the position. 

In stressful markets, mutual funds can see distributions of capital gains if there is a surge of redemptions, adding to the risk of a capital gains tax bill in concert with a losing position. With SMAs, this risk is nonexistent since securities are directly purchased. Instead, there is more flexibility to pursue the most tax-efficient strategy.

Finsum: Separately managed accounts offer certain tax advantages to investors over investing in ETFs or mutual funds. Over time, the boost to after-tax returns can be quite significant, especially for high-net-worth investors. 

Direct indexing continues its ascent and is forecast to exceed $1 trillion in assets within the next decade. In essence, direct indexing retains the primary benefits of passive investing while allowing for greater tax efficiency and personalization. 

It achieves this by buying the actual components of an index in a separately managed account (SMA). This means that tax losses can be harvested by selling losing positions and reinvesting the proceeds into positions with similar factor scores to ensure that the benchmark continues to be tracked. According to research, direct indexing can boost after-tax returns by 1 to 2% due to these savings. The effect is even more potent in periods with elevated volatility.

Direct indexing also allows for more customization to account for a client’s unique situation. For instance, if an investor has an oversized position in a specific company, that company would not be included in the index, and/or the specific sector could be underweighted. Similarly, if a client is sitting on large, unrealized gains, direct indexing can help reduce the tax burden while helping to construct a more diversified portfolio.

Direct indexing can be a way for advisors to give clients a strategy that accomplishes their financial goals in the long term, reduces tax payments, and aligns their investments with personal values and/or situation. This can help differentiate advisors in a competitive market and create a richer experience that leads to a stronger and deeper relationship with clients. 

Finsum: Direct indexing continues to experience rapid growth as it offers the benefits of passive investing with more tax efficiency and customization. For advisors, it also presents an opportunity.

Schwab Asset Management conducted its annual ETF and Beyond report in which it surveys a sampling of its own clients to gain insight into how investors are thinking. One of the most interesting findings was that Millennial investors are the demographic most interested in personalizing their portfolios and having their investments align with their values.

But, that instinct is shared by other age groups to a lesser degree. Overall, 88% of respondents said that they are looking to personalize their portfolios, while 78% want to align their investments with their personal values. 

65% of ETF investors said that it’s important to have more control over their investments, 61% want a greater ability to customize investments, and 61% are looking to optimize their tax situation. Of course, these factors are why direct indexing has been gaining in popularity in recent years. 

There’s also increased awareness as 87% of ETF investors are now familiar with the strategy in comparison to 80% last year. 69% of ETF investors, not in any direct indexing product, expressed interest in doing so over the next year. 

Not surprisingly, direct indexing is even more popular with Millennials as 53% are interested in learning more about it, in contrast to 34% of Gen X and 22% of Baby Boomers. Overall, all investors want more control of their portfolios and alignment with their values, but this trend is even more pronounced among younger investors. 

Finsum: Investors are looking for more control over their investments, tax savings, and alignment with their values. All 3 are possible with direct indexing.