Investors experienced a turbulent 2022, with high market volatility and a nearly 20% decline in the S&P 500 - the worst performance in 14 years. While uncertain markets can be unsettling, financial advisors have a unique opportunity to provide significant value by implementing tax-smart rebalancing strategies, which can help clients reduce or eliminate tax consequences in addition to optimizing advisors’ businesses for growth.
Today’s financial landscape is more competitive than ever for advisors, and offering value-added services centered on estate and tax planning is crucial for advisors to maintain a competitive edge and scale their businesses. Fully 80% of investors believe their financial advisors should prioritize minimizing their taxes and 90% are concerned that taxes will erode their investment profits over time.
Understanding Tax-Smart Rebalancing
Tax-smart rebalancing is a strategy by which advisors reduce or eliminate their clients’ tax liabilities through methods such as asset location optimization, tax-loss harvesting, and budgeting for capital gains. In the past, these methods were applied manually by advisors over the lifecycle of the portfolio. New technologies in the form of specialized model portfolios now allow for these methods to be considered automatically. The portfolio can be designed and consistently recalibrated with tax efficiency in mind.
This ongoing recalibration is essential for understanding the requirements of the tax-efficient client portfolio. Tax-efficiency is a year-round ongoing process that must be integrated throughout the lifecycle of an investment account. As the investment landscape evolves, so do the tax rules that govern the accounts. Tax-loss harvesting rules and practices help to minimize clients’ capital gain obligations and ultimately give advisors back their most valuable asset to begin with – time with their clients.
The Evolving Landscape of Tax-Saving Services
Clients are now seeking advisors who can assist in reducing their tax burdens in addition to managing their investments. Further, a growing pool of investors is increasing the competition among firms to enhance the value they offer to their clients. To satisfy this demand, 60% of independent registered investments advisors (RIAs) now provide tax planning services alongside traditional investment advisory services to their customers.
An aging population also means estate taxes and intergenerational wealth transfers are becoming increasingly significant. As baby boomers prepare to pass on approximately $70 trillion to their children, there is a growing need for advisors to help clients navigate the tax implications and procedures related to wealth transmission. However, a notable 62% of wealth managers admit they lack the confidence in understanding and catering to millennials, which by some estimates may lead at least 80% of millennial heirs to seek a new financial advisor. While this may present a challenge at first, advisors that can meet these needs will have a significant competitive and growth advantage.
Leveraging Tax-Smart Rebalancing for Growth
Tax-smart rebalancing of portfolios allows advisors to provide more than just tax benefits – it can optimize investment performance while providing healthy, risk-adjusted returns. By creating “tax-alpha,” advisors can fold in tax-aware strategies into investment management to offer clients both permanent and temporary tax savings depending on client goals. Models integrated with tax-specific instruments provide numerous opportunities to advisors such as managing estate taxes, offering tax-deferred solutions, upmarket service strategies, and scaling to downstream markets.
One prominent opportunity is the provisions of tax-deferred solutions which are increasingly sought by high-net-worth investors. The rise of direct indexing gave investors the ability to directly hold specific combinations of individual securities tailored to their inclinations, be it for tax management, impact or ESG investing, or other factor-based tilts. Direct indexing will play a pivotal role in the growth of separate accounts over the next couple of years but can also cause considerable tax obligations clients may not be aware of. To serve the affluent investor segment effectively, advisors may consider offering tax-aware planning services alongside individual investment account planning as part of their overall value proposition.
The impending generational wealth transfer also presents another significant opportunity. The projected $70 trillion that will be passed on may lead to many clients facing a federal estate tax rate of 40-50%. Advisors are presented with a tremendous opportunity to assist clients’ estates and the heirs of this wealth in both managing the tax implications and investing it appropriately.
Additionally, the adoption of upmarket service strategies is on the rise. Studies indicate that managing tax obligations is one of the most compelling ways for advisors to enhance the value-add of their clients’ portfolios. As federal estate, gift, and generation-skipping transfer taxes continue to increase, investors are understandably interested in reducing their tax burdens. The proportion of investors using tax and planning services is projected to grow significantly, from 30% in 2021 to 44% and 45% respectively by 2024.
Improving Operational Efficiency
In a landscape where talent shortages and competition persist, firms face the challenge of streamlining their workflows. By optimizing operational efficiency, organizations can establish standardized and well-documented rebalancing techniques. This, in turn, liberates advisors, allowing them to implement the firm’s distinctive investment approach with agility; responding more quickly to market dynamics, and ultimately expanding their books of business in a scalable and efficient manner.
A firm’s technological framework serves as means to effectively duplicate advisors themselves. intelliflo redblack brings comprehensive rebalancing and trading capabilities that let you rebalance households in a tax-aware manner using the industry’s most sophisticated location optimizer.
In the past, advisors were required to allocate specific time for tending to primary facets of their roles – first, advising and prospecting for new business, and second, account maintenance. The realm of account maintenance encompasses both lower-value, albeit necessary, tasks and the vital, albeit time-intensive, duty of rebalancing. Delegating these crucial portfolios responsibilities to models frees advisors from the burdensome tasks, enabling them to focus on dedicated time with their clients.
Overall, tax-smart rebalancing is not only a tax-efficient strategy but serves also as a growth driver for advisors. By offering tax-deferred solutions, addressing estate taxes, and adopting upmarket service strategies, advisors can enhance their value proposition in an increasingly competitive market. Scalability in rebalancing and trading is essential for reaching operational efficiency, and growth within a sound client advisory business.
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