It seems like the holy grail—save time for you and
money for your clients. Yet it’s out there. You
just have to take advantage of the tools available.
Investment-management software includes three
1 Portfolio Accounting
—software (like Morningstar
Office) that tracks each client’s investment
holdings, dividends, interest, realized gains/losses,
unrealized gains/losses, returns, etc.
2 Account Aggregation
ByAllAccounts) that retrieves financial data on
investments held outside of an advisor’s
direct management (such as 401(k)s and annuities)
and integrates that data directly into the
portfolio accounting software.
—software (like Morningstar
Total Rebalance Expert) that monitors clients’
accounts and calculates appropriate tax-efficient
trades for rebalancing, cash needs, and
tax-motivated transactions (such as tax-loss
harvesting, capital-gain-distribution avoidance,
and location optimization).
Advisors are expected to make sound investment
recommendations, track their clients’
investments, rebalance when necessary, and
provide periodic reports.
Using robust investment management software
can help advisors exceed client expectations
by lowering their tax liabilities and leave their
competition—and the robos—in the dust.
Tax savings can be classified into four
- Current Permanent
(Avoiding short-term gains)
- Current Temporary
- Deferred Permanent
(Holding appreciating assets
in taxable account)
- Deferred Temporary
(Holding bonds in retirement account—
Current tax savings means that the client will
receive an immediate tax benefit, while deferred
tax savings will be realized at some point
in the future. Permanent tax savings will never
be repaid, while temporary tax savings
might require repayment down the road.
The three types of software—portfolio accounting,
account aggregation, and rebalancing—can help
create all four of the different types of tax savings.
Here are seven ways that bumping up your
software investment can wow your clients:
1 Manage at the Portfolio Level
Many advisors and most robo-advisors manage
on an account-by-account basis. This means
that a “full pie” of asset classes is contained in
Managing at the portfolio level reduces the
number of transactions (rebalancing won’t require
you to buy, say, more global real estate in every
account or sell emerging-markets equity in
every account) and allows for location optimization
(holding appreciating investments in taxable
accounts, income-producing investments in
retirement accounts, and high-return investments
in Roth IRAs) to minimize taxes.
I explain it to clients this way:
“We hold ordinary income-producing investments
in retirement accounts because, if held in
taxable accounts, the interest income is taxable
each year. If bonds are held in retirement
accounts, the tax is deferred. Eventually when
you take the money out, it will be subject
to ordinary tax—which would be applicable
in a taxable account anyway. By holding
bonds in retirement accounts, you at least get
a compounding benefit.
“We hold appreciating assets in the taxable
account. Because appreciation isn’t taxed until
investments are sold, the investments are
essentially tax-deferred anyway. However, when
you sell, you will pay capital gains rates
on the gains. If you hold appreciating investments
in a retirement account, you will
eventually pay ordinary tax. That would be like
telling the IRS you’re OK with paying twice
as much tax.
“Finally, we hold high-return/high-risk investments
in the Roth IRA. This is because the Roth IRA
never pays tax, and we want the biggest bang for
2 Manage 401(k)s
Let’s face it: Employees don’t pay attention
to their 401(k) investment strategy. They might ask
you to review their allocations every year
or two, but they generally feel lost when it comes
to employer plans.
By integrating clients’ 401(k)s with their directly
managed accounts, you can provide
ongoing professional management of funds that
were previously largely ignored.
From my experience, clients are more than
happy to pay more management fees just for the
sense of relief!
There is also a huge tax benefit to this:
By managing at the portfolio level,
the advisor has more opportunities for location
optimization—meaning more fixed-income
investments can be allocated to the 401(k), leaving
the directly managed portfolio available for
3 Save on Current Taxes
Rebalancing software can prevent unnecessary
tax hits by avoiding short-term gains,
choosing high basis lots on sales, capturing
tax-loss harvesting opportunities, and
avoiding capital gains distributions at year-end.
Although all of these strategies merely postpone
tax, they are likely the strategies clients
will notice because they directly affect current tax
bills. The temporary savings won’t necessarily
need to be repaid if 1) the advisor continues
to manage taxes efficiently and 2) the investments
are held until the client is in a lower tax bracket
or passes away.
4 Great Benefits for Charitable Contributions
Using portfolio-accounting or rebalancing software
can identify holdings with long-term appreciation.
Clients who want to make donations can
contribute the most highly appreciated shares
to their favorite charities (or donor-advised
funds) rather than cash. They get the full
deduction at fair market value without paying tax
on the gain.
5 Be Instantly Responsive to Tax-Loss
Rebalancing software like Morningstar Total
Rebalance Expert can create tax-loss
harvesting trades across all your clients’ accounts
in minutes should a particular fund drop
By setting parameters, the software can:
- Harvest losses solely in taxable accounts.
- Harvest losses only when the loss is material
(as defined by the advisor).
- Avoid transactions when a redemption penalty
- Avoid transactions when a wash sale
6 Harvesting Gains
At times, it can be advantageous to harvest
This would occur when a client is in a low tax
bracket (such as the 10% or 15% brackets)—thus,
subjecting recognized gains to a 0% tax rate.
Because this is a rare freebie in the tax code,
advisors need to ensure that they don’t overlook
Again, portfolio-accounting or rebalancing
software can identify appropriate transactions to
take advantage of this beneficial tax strategy.
7 Avoid Capital Gains Distributions
Toward the end of each year, mutual funds
distribute internally recognized capital
gains to shareholders.
This phantom income must be reported on the
shareholders’ tax returns even though they
received no cash. Capital gains distributions are not a pleasant surprise to clients, yet most
advisors can’t or don’t want to spend the time
to avoid them.
Once the advisor has identified funds expecting
material distributions, Morningstar Total
Rebalance Expert merely needs the distribution
information entered for the currently held
fund and the replacement position (which should be a fund with lower or no expected capital
The software will create trades:
- Solely in taxable accounts.
- Where the net distribution savings are material
(as defined by the advisor) after considering
potential gains on sale.
Doing a better job for your clients doesn’t
have to mean spending more time. Using the right
software can help.
This article originally appeared in the December/January 2018 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.