Displaying items by tag: tax efficiency

According to Broadridge Financial, we are on the cusp of a meaningful shift in the wealth management universe as direct indexing represents the next evolution of passive investing. Over the last 20 years, we have seen exchange traded funds (ETFs) displace mutual funds as the primary vehicle for investing. Now, Broadridge believes something similar is happening with direct indexing. 

Some of the major reasons for this are low trading costs, fractional shares, and technology advances which make it accessible and practical for investors with much lower amounts to invest. Direct indexing assets are forecast to rise at a 12.4% rate over the next few years, outpacing ETFs, mutual funds, and SMAs. As a result, it’s becoming imperative to offer this service to clients who are particularly amenable to its tax optimization and personalization features.

Despite these trends, Broadridge reports that only 47% of executives and advisors were familiar enough with direct indexing to complete a survey about the subject. Additionally, only 14% of advisors currently recommend it to clients. According to the firm, advisors and practices should move quickly to embrace this technology as it has the potential to be a source of differentiation and value for clients. Client interest is especially high among Millennials and Generation Z due to their desire to align their investments with their personal values. 

Finsum: Broadridge Financial conducted a survey of advisors and executives about direct indexing. Despite promising long-term trends, it found that many are still not acting to embrace this opportunity. 

Active ETFs represent a fraction of the overall market of investable assets, but the future looks very promising given current growth rates. This is evident through the bevy of new active ETF launches which will continue in 2024. Last year, 75% of ETF launches were active. Additionally, according to Cerulli, 95% of ETF issuers have existing plans or are planning to launch active ETFs in the coming year. 

Some of these active ETFs will be conversions of active mutual funds, while others will follow a dual-class structure. In terms of why active ETFs are gaining traction, the biggest factor is the tax benefits of the ETF structure. In contrast, many investors in active mutual funds may find themselves with a tax bill if the fund takes profits on winning positions.

Additionally, the fee structure of ETFs is much simpler while it also leads to more transparency for investors. This appeals to many investors who are then able to hedge risk more effectively.  Currently, most of the focus on issuers is for transparent, active ETFs with 59% of launches falling in this category. One caveat is that active ETFs have failed to penetrate the institutional market as 80% of assets currently come from retail investors.

Finsum: Active ETFs had a strong year in 2023 and even more launches are planned for 2024. Here are the major factors driving the category’s growth. 

When it comes to investing for retirement, most think of IRAs and 401(k)s due to the unique tax advantages. However, there is a tradeoff as these accounts tend to be less flexible. According to Christine Benz, Morningstar’s director of personal finance and retirement planning, there are some upsides to investing for retirement in taxable accounts.

These advantages include the ability to save and invest as much money as available, withdraw funds with no penalty or limitations, and no constraints on investment choices. Using taxable accounts for retirement investing is also necessary for ‘super-savers’ who have maxed out contributions to tax-advantaged retirement accounts. 

Benz notes that with the right selection of investments, the taxable account can become as tax efficient as an IRA or 401(k). Additionally, it can help with financial goals of a short or intermediate nature like a down payment for a house, a remodeling project, or a vacation home. 

She notes that model portfolios are well-suited for tax-efficient investing in taxable accounts. She recommends structuring these model portfolios into 3 components. One is a liquidity basket for short-term spending needs, a high-quality municipal bond fund basket that is geared for withdrawals between 5 to 8 years, and the rest invested in a globally diversified basket of equities. 

Finsum: For retirement investing, there is still a place for taxable accounts especially for specific purposes. Here’s how to use model portfolios to achieve these goals.  

Franklin Templeton is optimistic about fixed income in the coming year due to the Federal Reserve ending its hiking cycle, and inflation continuing to trend lower. However, it believes that rates will remain at these levels for much of 2024 in order for inflation to fall to the Fed’s desired level, leading to a more challenging environment in the first-half of the year. 

Amid this backdrop, the firm is bullish on municipal bonds especially with so many investors on the sidelines, overweight cash, or in short-term credit. Municipal bonds offer historically attractive yields, favorable tax treatment, and a longer-duration which should outperform in an environment with falling rates and a flattening yield curve. 

The firm notes that local governments remain in strong shape from a fiscal perspective even despite a slowdown in economic activity and rising costs. Many still have excess funds leftover from federal aid during the pandemic and have been relatively disciplined in terms of spending. Further, muni bonds have lower default rates than corporate credit while also having higher after-tax returns. Franklin Templeton believes many investors will reallocate from money markets into municipal bonds in order to lock in yields at these levels especially as monetary policy eases. 

Finsum: Franklin Templeton is bullish on fixed income in the coming year. It also highlights a bullish case for municipal bonds due to the sector’s strong fundamentals and favorable positioning in this macro environment. 

A familiar mantra of financial advisors and tax planning experts is that it’s not what you earn; it’s what you get to keep that matters. This principle underscores the significance of effective tax management strategies within a taxable investment portfolio. An essential technique in optimizing after-tax returns is tax-loss harvesting, which involves selling investments at a loss to offset taxable gains in the same year.

A powerful tool for executing this strategy is direct indexing. Unlike product structures like mutual funds, direct indexing accounts allow investors or their advisors to buy and sell individual securities. This granular control enables them to recognize losses for tax purposes while maintaining their investment strategy.

However, timing is crucial. Establishing a direct indexing account early in the taxable year affords the account holder increased flexibility later. This positions them to maximize the opportunities for tax-loss harvesting as they accumulate over the year. By doing so, advisors can proactively manage the portfolio to leverage potential tax savings, which can be particularly beneficial when preparing for year-end financial discussions with clients.

Essentially, the sooner an advisor sets up a direct indexing account for their client, the more they can potentially benefit from tax-loss harvesting strategies during the year.

Finsum: Advisors can help their clients keep more of what they earn by utilizing direct indexing accounts to harvest tax losses throughout the year.