Harvesting Losses
Although tax-aware managers can harvest losses that occur in their own portfolios, they will have no idea of the gain and loss positions held elsewhere in the client's accounts. As investors, however, we (or a financial advisor on our behalf) can carefully monitor activity across the portfolio and coordinate among managers to net out gains and losses, or at least minimize net gains. If Manager A has losses that can be realized and Manager B has gains he cannot offset, we can work with the two managers to net out the tax consequences across the two portfolios.
In this, as in so many other areas, the importance of engaging a qualified master custodian for our investment assets can hardly be overemphasized. Asset custody is discussed in Chapter 22, but for purposes of this discussion the importance of a master custodian lies in (a) the custodian's role as the keeper-of-record for tax cost basis information on all securities in the portfolio (including identification of tax lots), and (b) the custodian's ability to produce consolidated account statements. These services allow us to observe our tax position across the portfolio, regardless of who is managing our money or how many managers we have engaged. Often, we are able to do so online and in something approaching real time. Absent a central custodian, we are reduced to poring over paper statements that arrive at different times, or trying to download online information from many different, usually incompatible, sources.
Even among investors who use a custodian and practice tax loss harvesting, a common mistake is waiting until near the end of the year to cross gains and losses. Our managers are buying and selling securities throughout the year. If we wait until November or December to look at our unrealized gain-loss positions, we will have missed many, many opportunities to reduce taxes because most of the tax-realization events will already have occurred. Families will likely find that reviewing tax savings opportunities every quarter will prove optimal, most efficiently balancing investment and tax considerations.
Advisors have gotten better in recent years at building tax awareness into their work with wealthy families. But there is still a lot of work to do in terms of keeping tax issues at the forefront of everything we do for our clients. Taxes represent a huge drag on investment returns, and the more we can minimize that drag, the better off our clients will be.
That said, it's also important not to allow the tax tail to wag the investment dog. Getting this balance right isn't easy, especially when we are being pressed by clients to take action to reduce taxes even though it means making unwise investment moves. But, hey, that's why they pay us the big bucks!