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FAs Lose UHNW Clients if they Ignore Taxes

By Crucial Clips     November 9, 2016
The following text is a transcript of a portion of a speaker's presentation made at an industry conference or during an interview. This transcript solely represents the view of the individual who spoke, and not the view of Financial Advisor IQ or any other group.
Source: FA-IQ, Oct. 5, 2016 

BRUCE LOVE, MANAGING EDITOR, FINANCIAL ADVISOR IQ: This is Bruce Love with Financial Advisor IQ, and I'm speaking with Paul Bouchey, the CIO of Parametric. Paul, do you think that advisors should calculate taxes as well as fees when they're looking at performance? I know this is quite a gripe of the ultra-high net worth community when they're dealing with advisors. What's the problem?

PAUL BOUCHEY, CHIEF INVESTMENT OFFICER, PARAMETRIC: Well, that's right. People often pay attention to fees as an important cost to investing. Anything that reduces returns over time can have a significant effect on the compounding of investments over long periods. So fees are good to look at. But taxes can be even 1% to 3% per year, depending on your tax rate.

BRUCE LOVE: Why should financial advisors look at taxes as well as fees?

PAUL BOUCHEY: Well, once you can measure the after-tax returns of the portfolio, you can start to do things for the portfolio to improve the total returns or to reduce the tax drag on the portfolio. So a lot of investors know about municipal bonds. But you can also invest in passive index portfolios, which tend to be lower tax and lower fee. And the benefit could be great. You can save up to, like I said, tax drag is 1% to 3% per year, and that's the potential savings, as well, on the compounding of your portfolio.

BRUCE LOVE: Is it difficult for advisors to do this, though? I mean is it extra effort?

PAUL BOUCHEY: Yeah, I mean, it definitely does take more work to report the after-tax returns and to educate clients on how to understand those returns. But it's definitely worthwhile. It's one of the areas that an advisor can really add value for their clients.

BRUCE LOVE: How do you bring it up with clients, if they're used to not talking to you about their taxes?

PAUL BOUCHEY: Well, I think most clients are quite open to it. I think that people have a strong aversion to paying taxes. I mean, a lot of people feel as though they want to pay taxes to support the government, but they'd be just as happy paying maybe half or a third of the taxes that they pay.

BRUCE LOVE: What does it mean practically for an advisor?

PAUL BOUCHEY: Well, they have to think about what specific tactics they want to do to try to reduce the tax drag of the portfolio. So it could be investing in municipal bonds on the fixed income side, investing passively to reduce the turnover of the portfolio and therefore reduce the capital gain. But also even going into a separately managed account can create a lot of customization around taxes and make the whole portfolio much more tax efficient.

BRUCE LOVE: Are there any portfolio management or asset allocation considerations if you're looking at taxes, as well?

PAUL BOUCHEY: Definitely. One of the key concepts is building a core and a satellite portfolio. So the core of the portfolio should be very low-cost and tax efficient. And that's best done in a separately managed account. And the satellites can be less tax efficient. They could be ETFs or active management strategies. And the capital gains realized by the satellite part of the portfolio can be offset by the capital losses being generated in the core.

BRUCE LOVE: Is this an issue just for ultra-high net worth clients, or is it an issue more across the board?

PAUL BOUCHEY: Well, I think it is – this issue of costs and drags on the portfolio face all investors. So it could be transaction costs. It could be commissions or fees. All of these tend to reduce portfolio returns over time. But taxes, for taxable investors, it's particularly difficult on total returns.

BRUCE LOVE: Paul, thank you very much.

PAUL BOUCHEY: All right. Thank you.