There are a number of areas to evaluate when you're seeking to understand just how tax-efficient your financial strategies performed in 2016.
First, let's look at tax-loss harvesting. If you're not familiar with that term, it is an investment strategy that you can use when you are invested in a holding that loses value. Instead of just accepting that it dropped and hoping for a brighter tomorrow, you can sell the investment and reinvest the remainder, preferably in a similar asset (keeping you on the right side of the so-called "wash-sale rule") to maintain your desired asset allocation. The loss can be claimed on your taxes, and your market exposure and investment cash flow will remain the same.
Let's get specific. In February 2016, there were terrific opportunities for tax-loss harvesting. As the market dipped, did your advisor or online platform sell underperforming assets while maintaining your market exposure? These aren't the kinds of moves you can make at the end of a quarter and expect the market to wait for you. Paying attention to tax-loss harvesting options requires your advisor to be knowledgeable about taxes and actively watching the market. Frankly, every advisor today should have access to technology that alerts him or her to act. With the advent of better and better technology there's really no excuse for an advisor who isn't harvesting your losses.
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While tax-loss harvesting is a fairly straightforward idea, this next strategy requires a little bit more tactical prowess. You may be a much more complex investor than the scenario I am about to lay out, but for the purposes of explanation, we can think about a fairly basic portfolio structure.
For the sake of this discussion, we'll assume that our sample investor has five accounts that should be diversified into 50 percent bonds and 50 percent stocks. If each of those accounts is set up with the 50 percent split across the board (including individual retirement accounts, Roth IRAs and brokerage accounts), the tax implications haven't been factored in.
If your financial advisor has considered location optimization, you should expect to see the most aggressive investments, or more equities, sitting inside of your Roth IRA because they are growing tax-free. A much larger selection of bonds should sit inside of your IRA, where the monthly or quarterly dividends or interest would be completely tax-deferred. Taxable accounts should have less volatility, so you can hopefully hold them for more than one year to take advantage of the lower long-term capital gains tax rate. The 50 percent bond/50 percent stock allocation can still be achieved inside your total portfolio.