Death and Taxes

From time to time this blog will invite guest columnists to weigh in. Today Harvey Siegel, Senior Financial Advisor and colleaugue at Apella Capital in Lenox, MA shares his thoughts.

"Nothing can be said to be certain, except death and taxes."
                                                                                  Benjamin Franklin

All major stock indices rose in 2017. Double digit returns were not uncommon for investors holding a balance of stocks and bonds.

All good? Well, maybe. If you require withdrawals from your investments to sustain spending, rising markets are favorable. If, on the other hand, you are a strong periodic saver with years before spending requirements, the better outcome would be if you bought when prices were lower rather than higher - it’s always something.

Did the experts get it right?, Hardly, just over a year ago the Wall Street Journal reported that according to Bespoke Investment Group, Wall Street’s equity strategists were the most bearish on equities for 2017 as they had been about a year since 2005. The estimate was a gain of only about 5 percent for the S&P 500 (up more than 20% for 2017). We wonder about an estimate of a positive 5 percent return that’s called the most bearish in twelve years or so. Those of us on the “buy side” (retail and institutional investors) might think that the “sell side” (brokers, bankers and their strategists) is hesitant to deliver a negative outlook. Less gloom, more sales.

Our take - markets do what they do with no regard to what we think they’ll do or when we think they’ll do it. Expect ups, downs, unexplainable rallies and retreats and the occasional calamitous decline just to see if we are paying attention. Other than adopting a responsible investment strategy and process, there’s little one can do that will impact gross or “top line” results. In fact, most of what ordinary investors tend to do will likely reduce top line returns. That includes selling in anticipation of a decline, buying in anticipation of a rally and acting on a third party’s forecast.

What we can control though is the portion of top line returns we get to keep. We can do that by reducing our costs in general and actively managing what we believe is the largest cost of investing: the aggregate of taxes imposed on our investment income.  

The concept isn’t as broadly accepted as one would think. There has long been controversy about the degree of attention one should pay to the imposition of taxes on investment returns. Maxims abound: “Don’t allow taxes to drive investment decisions” and “The certain way to minimize taxes is to eliminate profits". The premise being that an investor (or professional manager) unencumbered by tax considerations, will post net (of taxes) investment returns that will exceed those of a similarly talented investor (or manager) mindful of tax considerations. We don’t buy the arguments. Our generous critique is that an investor of one’s own or more likely other people’s money might actually believe that their skill in timing, selection and placement trumps the post-tax returns of an investor attentive to tax consequences of investment decisions. The cynical critique is that effective tax management is administratively inefficient (regardless of identical asset allocation strategies, you shouldn’t apply the same model investment portfolio to an after-tax account and a qualified retirement account) and the benefits aren’t obvious (tax savings don’t appear on investment statements or performance reports).  Less work, same pay.

The 2017 tax reform act was enacted shortly before year-end. We followed the process closely. We hoped for more policy than politics, we got less of the former. The act is wide ranging; its impact on corporate and business taxes, International trade and transactions and tax-exempt organizations is consequential. Our focus though is individuals and families, specifically incentives for saving, the taxation of investment income, taxation on generational transfer and the taxation of inherited assets. Ultimately the impact of tax reform on any individual taxpayer will depend on individual circumstances.  In general though, we’re comfortable saying it preserves the incentives for saving and continues to reward the employment of tax management strategies.