Pre-tax portfolio performance gets most of the attention from investors. Yet only after-tax returns provide the dollars available for us to spend, invest, give, or leave to the next generation.

Investment decisions are rarely made in isolation. Portfolio choices have tax consequences, and tax planning opportunities have investment implications. Our role is to coordinate both as part of a unified lifetime wealth strategy.

For example, decisions involving Roth conversions, charitable giving, Social Security, Medicare premiums, Required Minimum Distributions, and estate planning all influence various portfolio selections and placements. Rather than treating investments and tax planning as separate decisions, we coordinate them as part of our long-term tax management.

As mentioned in the first two articles in this Lifetime Tax Planning series, when evaluating your family’s circumstances, opportunities we routinely explore include:

• Does a Roth conversion make sense this year…over several years?
• How best can we coordinate investment decisions with your charitable giving intentions and estate plan?
• Are lower-income years before Required Minimum Distributions being fully utilized while considering Medicare premium thresholds?
• Does it make sense to delay Social Security, considering both spouses?
• For married couples, should more tax-free assets be preserved for the surviving spouse as the filing status changes?

These planning opportunities and investment decisions shape how we manage your portfolio. The portfolio itself then presents additional opportunities to improve long-term after-tax results.

One of the most valuable aspects of tax-efficient portfolio management happens quietly behind the scenes. It rarely appears on a quarterly investment report. Throughout the year, we continually evaluate questions such as:

• Should gains be realized this year or deferred?
• Are there losses worth harvesting to offset current or future gains?
• Can capital loss carryforwards be used more effectively?
• Which tax lot should be sold?
• Are irrevocable trusts being managed as tax efficiently as possible?
• How should withdrawals be sourced to minimize lifetime taxes?
• Are investments located in the accounts where they are expected to produce the best long-term after-tax outcome? (Asset location is discussed in more detail below.)

No single decision is likely to transform a portfolio in one year. Collectively, however, hundreds of thoughtful decisions made consistently over time can have a meaningful impact on lifetime after-tax wealth.

Asset Location: It’s Not Just What You Own—It’s Where You Own It

When most investors think about improving returns, they focus on what they own.

Which stocks? Which bonds? Which funds?

Those are certainly important decisions.

But another question can matter just as much:

Where should those investments be owned?

Two families can hold remarkably similar portfolios yet experience very different after-tax outcomes simply because one portfolio was built with taxes in mind.

That’s why we often say:

How investments are owned can be nearly as important as what investments are owned.

Rather than managing each account independently, we begin by viewing your household as one integrated portfolio.

From there, we determine which investments belong in which accounts based on their tax characteristics and your long-term objectives. A taxable account, Traditional IRA, Roth IRA, trust, or inherited IRA are not simply different places to hold investments—they are different tax environments. The same investment can produce very different after-tax results depending on where it is held.

Asset location is not simply about reducing this year’s taxes. It’s about anticipating the taxes that may arise years—or even decades—from now.

As retirement progresses, Required Minimum Distributions, Roth assets, taxable accounts, charitable giving strategies, and estate planning begin interacting in increasingly important ways. Our objective is to coordinate those moving pieces so they work together rather than against one another. Examples include:

• Appreciated investments held in taxable accounts may receive a step-up in basis at death, making them more valuable to retain than to gift during life.
• Qualified Charitable Distributions become available several years before Required Minimum Distributions begin, creating a valuable planning opportunity.
• Roth IRAs currently have no Required Minimum Distributions during the owner’s lifetime, making them attractive accounts for long-term growth assets.

Why One Account May Look Unbalanced

This planning approach often surprises clients.

An individual account may appear unusually aggressive or unusually conservative when viewed by itself.

A Roth IRA may hold mostly equities.

A Traditional IRA may emphasize income-producing investments.

A taxable account may appear different still…holding larger than expected cash for ongoing withdrawals.

We do not seek to balance every account individually. We seek to balance your household portfolio as a whole.

Rather than evaluating accounts in isolation, we evaluate how they work together to support your family’s long-term after-tax goals.

Your agreed-upon Investment Policy (asset allocation) remains intact. It is simply distributed across your various accounts in the way we believe is most tax-efficient over many years.

If a single account has ever looked out of step with the others, this is usually why. We are always happy to walk through the reasoning behind your portfolio’s design.

The Bottom Line

Investment management isn’t simply about selecting good investments.

It is also about thoughtfully managing where investments are held, when taxable events occur, and how each investment decision fits within your broader lifetime tax plan.

As noted, much of this work happens quietly behind the scenes and may never appear on a performance report. Yet over time, these decisions can have a meaningful impact on your family’s lifetime after-tax wealth.

Investment success isn’t measured by pre-tax returns. It’s measured by how much of your wealth remains available to accomplish the goals that matter most to you.

“Should I be investing in ‘alternative investment’ funds?” “If so, then what is Tanglewood’s potential role in that process?” Several clients have posed such questions to us recently. I will address them after giving a brief history of alternative investments.

Alternative Investments Over the Years.

Over my 22-year investment career, different strategies of “alternative investments” have been “hot”. Perhaps you remember them.

In the early 2000s it was Venture Capital (VC). They raised money to get in early on the next Dot Com mega success. Then we had the tech crash, poor returns, and VCs fell out of favor.

In the mid-2000s, it was Private Real Estate which ended poorly during the Global Financial Crisis (GFC).

Hedge Funds gained prominence during the GFC for their exceptional returns when other asset classes fell. This fostered a scramble for these funds as many investors were convinced it should be a permanent holding to hedge risk in their portfolios.

What worked spectacularly in the GFC did not work nearly so well for investors in the following years when markets rose sharply. With some notable exceptions, those hedged investments became anchors on investors’ returns.

As the bull market continued, Private Equity and Private Real Estate took over as the most popular alternative investments. These investments took advantage of the cheap money available because of the Federal Reserve’s zero interest rate policy. This “leveraging” worked remarkably well so long as the underlying asset values went up and interest rates remained low.

But now the attractive environment that Private Equity and Private Real Estate took advantage of is reversing. With interest rates spiking over the last couple of years, the cost of their leverage has increased dramatically and the multiples on exit are smaller than expected.

The most recent “must have” alternative investment category is Private Credit (private loans). The big hurdle here is taxation.

Unlike pensions and endowments, the traditional investors in alternative investments, high net worth investors pay income tax. As the return is ordinary income, investors end up giving a significant portion of the return to Uncle Sam.

Should I be Investing in Alternative Investment Funds?

We believe that your “safe capital” (see page 8) should be sufficient before considering alternative investments. Also, the history of private investments makes us more than a little cautious about recommending such investments as they tend to run hot and cold and are not liquid.

Of course, there are outstanding private investments. However, finding them requires a great deal more due diligence because of the opaqueness of their regulatory filings, potential leverage and lack of liquidity.

At the end of the day, the decision should be almost exclusively based on the specific investment and the investment manager (sponsor’s team) that employs the investment strategy.

Proper due diligence should focus on prior performance and how they achieved that track record. Other important factors that will play in that decision are fees, other costs, level of leverage, liquidity, and correlation with other investments.

There is certainly a place for private investments in some high net worth investor portfolios. They can provide some added level of diversification through access to opportunities that are not available in the public stock or bond markets.

These are some considerations for those interested in looking further:

1. It should not alter your lifestyle if you lose the entire sum invested.

2. Make sure you are working with a knowledgeable professional with a verifiable track record.

3. Ideally, you will outlive the investment. These investments can be a nightmare in an estate settlement.

4. Be prepared for the extra paperwork and filing at tax time.

5. You should have the time and “bandwidth” to follow your alternative investments.

6. You should consider special industry or regional knowledge that complements this investment.

What is Tanglewood’s Role?

Until recently, most alternative investment companies were only open to pensions, endowments and insurance companies. Over the last five years almost all of the major alternative investment companies have created “Private Wealth Solutions” (PWS) groups to work with wealth advisors like Tanglewood.

PWS groups did two things that made investing more palatable for individuals. First, their new offerings have been designed to be somewhat more liquid than traditional private funds. Second, they qualified them to be acceptable to platforms like Schwab.

The final hurdle for them was administrative. Knowing the subscription system and the number of K-1s would face some resistance from individual investors, systems were developed to mitigate some of the tax and paperwork issues.

Given the ever evolving alternative investment world, we have almost unlimited options for what we can invest in, and the ways that we can invest in them. We intend to explore this further with interested Wealth Management clients this fall.

Disclosures