1 00:00:00,080 --> 00:00:03,440 Speaker 1: I'm Barry Retults, and on this episode of At the Money, 2 00:00:03,960 --> 00:00:08,760 Speaker 1: we're going to discuss tax lost harvesting via direct indexent. 3 00:00:12,800 --> 00:00:15,239 Speaker 2: Effective tax policy. 4 00:00:15,040 --> 00:00:19,720 Speaker 1: Net migration of taxpayers at the upperanjust reduce taxes for everybody, 5 00:00:19,760 --> 00:00:25,479 Speaker 1: wetting taxes for individuals and businesses tax tax. One of 6 00:00:25,480 --> 00:00:29,080 Speaker 1: the most popular innovations of the past fifty years has 7 00:00:29,160 --> 00:00:33,160 Speaker 1: been the tax qualified account. You know these is Boro 8 00:00:33,240 --> 00:00:37,279 Speaker 1: one k's, IRA's Boro three b's. They've become more popular 9 00:00:37,400 --> 00:00:40,920 Speaker 1: because you get to keep more of your net after 10 00:00:41,000 --> 00:00:46,120 Speaker 1: tax returns. Savvy investors understand this. They maximize their tax 11 00:00:46,159 --> 00:00:50,960 Speaker 1: advantaged accounts. What about your taxable accounts? How can you 12 00:00:51,000 --> 00:00:55,240 Speaker 1: maximize your net after tax equity returns from your non 13 00:00:55,360 --> 00:00:59,760 Speaker 1: tax exempt portfolios. Well, some investors have turned to direct 14 00:00:59,800 --> 00:01:03,760 Speaker 1: ind to do just that. They reduce the capital gains 15 00:01:03,760 --> 00:01:08,800 Speaker 1: they pay on appreciated stock by improving their tax loss harvesting. 16 00:01:09,600 --> 00:01:13,039 Speaker 1: I'm Barry Ridults and on today's edition of At the Money, 17 00:01:13,520 --> 00:01:18,160 Speaker 1: we're going to discuss using direct indexing to maximize your 18 00:01:18,360 --> 00:01:23,120 Speaker 1: after tax net equity returns. To help us unpack all 19 00:01:23,200 --> 00:01:26,520 Speaker 1: of this and what it means for your portfolio, let's 20 00:01:26,520 --> 00:01:31,080 Speaker 1: bring in Ari Rosenbaum of O'Shaughnessy Asset Management, now a 21 00:01:31,200 --> 00:01:36,880 Speaker 1: division of investing giant Franklin Templeton. Ari Rosenbaum, welcome to 22 00:01:36,959 --> 00:01:38,319 Speaker 1: at the Money Barry. 23 00:01:38,360 --> 00:01:40,240 Speaker 2: Thanks so much for the opportunity to be here. 24 00:01:40,319 --> 00:01:43,959 Speaker 1: So before we get started, full disclosure, My firm Redults 25 00:01:44,120 --> 00:01:46,880 Speaker 1: Wealth Management was one of the first clients to use 26 00:01:46,880 --> 00:01:51,920 Speaker 1: O'Shaughnessy's direct indexing product Canvas. We currently have over a 27 00:01:52,000 --> 00:01:55,000 Speaker 1: billion dollars on that platform. So I just want everybody 28 00:01:55,040 --> 00:01:57,720 Speaker 1: to know disclosures out there. We never get in trouble 29 00:01:57,760 --> 00:02:01,560 Speaker 1: by disclosing more rather than less. So Ari, for the 30 00:02:01,640 --> 00:02:04,800 Speaker 1: late person, let's talk a little bit about direct indexing 31 00:02:04,960 --> 00:02:10,160 Speaker 1: and tax loss harvesting. For the typical non tax deferred 32 00:02:10,200 --> 00:02:14,519 Speaker 1: account that maybe consists of a dozen mutual funds and ETFs, 33 00:02:15,080 --> 00:02:17,400 Speaker 1: what does tax loss harvesting look like there? 34 00:02:17,760 --> 00:02:21,400 Speaker 2: Tax loss harvesting and a mutual funder in ETF would 35 00:02:21,440 --> 00:02:25,480 Speaker 2: be done at the price of the funder. The ETF 36 00:02:25,919 --> 00:02:28,400 Speaker 2: would be selling out of the entire position of the 37 00:02:28,440 --> 00:02:29,399 Speaker 2: funder the ETF. 38 00:02:29,480 --> 00:02:31,520 Speaker 1: So, in other words, I have a dozen funds, one 39 00:02:31,560 --> 00:02:34,880 Speaker 1: of them is doing poorly that year, I sell that funds. 40 00:02:35,360 --> 00:02:39,080 Speaker 1: I replace it with a similar fund and capture that 41 00:02:39,160 --> 00:02:44,280 Speaker 1: loss to offset my gains. How big of a harvest, 42 00:02:44,800 --> 00:02:48,400 Speaker 1: how much taxes can I avoid through that method. 43 00:02:48,560 --> 00:02:51,079 Speaker 2: The challenge with that is that markets go up more 44 00:02:51,080 --> 00:02:54,000 Speaker 2: often than they go down. Seventy five percent of years 45 00:02:54,040 --> 00:02:55,960 Speaker 2: since the founding of the S and P. Five hundred, 46 00:02:56,040 --> 00:03:00,079 Speaker 2: the market's actually up, and so the opportunities for harvesting 47 00:03:00,080 --> 00:03:04,840 Speaker 2: in mutual funds or ETFs can be less because generally speaking, 48 00:03:04,919 --> 00:03:07,520 Speaker 2: those strategies are going to be at a net gain. 49 00:03:07,760 --> 00:03:11,160 Speaker 1: So now let's look within the wrapper of the mutual 50 00:03:11,160 --> 00:03:14,280 Speaker 1: funds or within the ETF. Tell us a little bit 51 00:03:14,280 --> 00:03:17,680 Speaker 1: about direct indexing and how that allows us to access 52 00:03:18,560 --> 00:03:21,240 Speaker 1: more of the losses that take place within those wrappers. 53 00:03:21,320 --> 00:03:23,560 Speaker 2: Great question. So the benefit of a mutual fund or 54 00:03:23,600 --> 00:03:27,160 Speaker 2: an ETF is that you're getting a diversified portfolio and 55 00:03:27,280 --> 00:03:31,600 Speaker 2: professional oversight, but again you've got that net gain generally 56 00:03:31,639 --> 00:03:35,200 Speaker 2: over time. In a direct index you're getting that same 57 00:03:35,320 --> 00:03:40,680 Speaker 2: professional oversight and diversification, but instead of investing in a 58 00:03:40,720 --> 00:03:44,280 Speaker 2: product that's got one price, you've got access to the 59 00:03:44,360 --> 00:03:49,440 Speaker 2: individual securities underneath, all trading at different prices. In essence, 60 00:03:49,720 --> 00:03:52,760 Speaker 2: you're getting a strategy that's very similar to say an 61 00:03:52,840 --> 00:03:55,760 Speaker 2: S and P five hundred index or mutual fund, but 62 00:03:55,880 --> 00:03:58,360 Speaker 2: you're investing in the individual constituents. 63 00:03:58,600 --> 00:04:01,200 Speaker 1: So in other words, I will own in a direct 64 00:04:01,200 --> 00:04:04,160 Speaker 1: index product all five hundred of the S and P 65 00:04:04,280 --> 00:04:07,760 Speaker 1: five hundred, Or let's take the Vanguard Total Market that's 66 00:04:07,800 --> 00:04:10,960 Speaker 1: like twenty three hundred stocks something like that. You literally 67 00:04:11,000 --> 00:04:12,920 Speaker 1: own all of those stocks individually. 68 00:04:13,000 --> 00:04:15,480 Speaker 2: A little bit less than that, say, probably three hundred, 69 00:04:15,520 --> 00:04:18,520 Speaker 2: because many of those stocks had very very small positions 70 00:04:18,800 --> 00:04:20,719 Speaker 2: in the S and P five hundred that really aren't 71 00:04:20,920 --> 00:04:25,160 Speaker 2: meaningful to returns, so we for practical purposes remove those 72 00:04:25,200 --> 00:04:26,000 Speaker 2: from the portfolio. 73 00:04:26,000 --> 00:04:29,200 Speaker 1: All right, what about a bigger index like the Vanguard 74 00:04:29,200 --> 00:04:31,080 Speaker 1: Total Return Total market return? 75 00:04:31,160 --> 00:04:33,600 Speaker 2: Again similar, probably a few hundred stocks. 76 00:04:33,640 --> 00:04:36,839 Speaker 1: Okay, So now a typical year goes by and the 77 00:04:36,920 --> 00:04:40,919 Speaker 1: mutual fund is up. So if you're holding the S 78 00:04:40,960 --> 00:04:44,919 Speaker 1: and P five hundred, there may not be losses to harvest. 79 00:04:45,400 --> 00:04:49,080 Speaker 1: But what if you're holding the three hundred companies within 80 00:04:49,160 --> 00:04:49,880 Speaker 1: that index. 81 00:04:50,080 --> 00:04:53,719 Speaker 2: Historically, what we see in a large cat passive portfolio 82 00:04:53,880 --> 00:04:57,159 Speaker 2: like that, year by year, about thirty six percent of 83 00:04:57,160 --> 00:05:00,680 Speaker 2: the individual stocks are down, even if the index as 84 00:05:00,720 --> 00:05:03,680 Speaker 2: a whole is up. In a fund or an ETF. 85 00:05:03,839 --> 00:05:07,800 Speaker 2: Because it's up, you can't extract that for tax purposes. 86 00:05:08,120 --> 00:05:11,200 Speaker 2: But in a direct index, you can get at those 87 00:05:11,279 --> 00:05:14,520 Speaker 2: thirty six percent of stocks by selling those that are 88 00:05:14,520 --> 00:05:19,960 Speaker 2: at a loss, maintaining the fidelity towards your overall investment strategy, 89 00:05:20,240 --> 00:05:23,320 Speaker 2: and use those losses to offset gains over time. 90 00:05:23,480 --> 00:05:26,599 Speaker 1: So when I sell those individual companies, am I replacing 91 00:05:26,640 --> 00:05:28,480 Speaker 1: them with something? Or am I just sitting in cash? 92 00:05:28,600 --> 00:05:32,840 Speaker 2: You're replacing them with stocks that have characteristics that are 93 00:05:32,880 --> 00:05:35,600 Speaker 2: similar to the ones that you've sold out, so that 94 00:05:35,680 --> 00:05:40,560 Speaker 2: you're keeping that underlying investment strategy similar to what you intended. 95 00:05:40,600 --> 00:05:42,760 Speaker 1: So it may not look exactly like the S and 96 00:05:42,839 --> 00:05:48,280 Speaker 1: P five hundred, but mathematically it'll perform similarly. That's the expectation. 97 00:05:48,480 --> 00:05:49,120 Speaker 2: Very similarly. 98 00:05:49,160 --> 00:05:55,400 Speaker 1: So, if I'm managing tax loss harvesting with fifteen mutual 99 00:05:55,440 --> 00:06:00,119 Speaker 1: fund ETF portfolio, the general rule of thumb is, hey, 100 00:06:00,160 --> 00:06:04,719 Speaker 1: twenty twenty five basis points of your portfolio's gains can 101 00:06:04,760 --> 00:06:08,200 Speaker 1: be offset with losses. What do those numbers look like 102 00:06:09,080 --> 00:06:12,040 Speaker 1: if I'm holding a few hundred stocks instead. 103 00:06:12,040 --> 00:06:14,880 Speaker 2: So our research suggests that over a full market cycle, 104 00:06:14,920 --> 00:06:17,479 Speaker 2: it would be more like about a half a percent 105 00:06:17,960 --> 00:06:19,760 Speaker 2: to percent over time. 106 00:06:19,600 --> 00:06:22,599 Speaker 1: So fifty to one hundred basis points versus twenty to 107 00:06:22,680 --> 00:06:26,920 Speaker 1: twenty five exactly. And I recall in the first quarter 108 00:06:26,960 --> 00:06:31,039 Speaker 1: of twenty twenty, right as the pandemic ramped up, the 109 00:06:31,160 --> 00:06:34,400 Speaker 1: S and P five hundred fell thirty four percent within 110 00:06:34,440 --> 00:06:37,920 Speaker 1: that first quarter. It bottomed a few days before the 111 00:06:38,000 --> 00:06:42,680 Speaker 1: quarter ended, and right as a typical tax lost harvesting 112 00:06:43,360 --> 00:06:47,320 Speaker 1: and rebouncing took place. How did that quarter look for 113 00:06:47,400 --> 00:06:50,840 Speaker 1: people invested in a direct indexing product like Canvas. 114 00:06:50,960 --> 00:06:53,000 Speaker 2: Yeah, we were doing a multiple of what we would 115 00:06:53,040 --> 00:06:57,400 Speaker 2: have normally seen, so certainly after tax benefits north of 116 00:06:57,520 --> 00:07:01,320 Speaker 2: three percent three hundred basis points over time, where we 117 00:07:01,400 --> 00:07:04,679 Speaker 2: would have normally expected between fifty to one hundred. 118 00:07:04,960 --> 00:07:08,120 Speaker 1: So that's a huge number. I recall seeing some portfolios 119 00:07:08,160 --> 00:07:10,880 Speaker 1: that were even more than that, four hundred four to 120 00:07:10,960 --> 00:07:15,880 Speaker 1: fifty five hundred. Let's put this into context. Typically people 121 00:07:15,960 --> 00:07:19,760 Speaker 1: take three years, five years, seven years, ten years to 122 00:07:19,840 --> 00:07:23,880 Speaker 1: kind of work out of those positions and manage their 123 00:07:24,040 --> 00:07:29,040 Speaker 1: tax obligations. How much can this accelerate that process and 124 00:07:29,080 --> 00:07:33,920 Speaker 1: allow people to either diversify or cash out sooner than 125 00:07:34,320 --> 00:07:35,360 Speaker 1: the typical route. 126 00:07:35,440 --> 00:07:38,240 Speaker 2: Yeah, I think that in this regard there's both a 127 00:07:38,360 --> 00:07:42,240 Speaker 2: risk and a tax benefit. When you think about individual 128 00:07:42,320 --> 00:07:47,640 Speaker 2: positions in stocks, our research actually suggests that most individual 129 00:07:47,680 --> 00:07:51,800 Speaker 2: companies underperform the market, and do so with about twice 130 00:07:51,840 --> 00:07:55,480 Speaker 2: the volatility over time. You had mentioned the pandemic. We 131 00:07:55,600 --> 00:07:59,240 Speaker 2: actually have an investor that came to us shortly before 132 00:07:59,280 --> 00:08:02,360 Speaker 2: the start of twenty twenty with about half of their 133 00:08:02,400 --> 00:08:06,640 Speaker 2: net worth invested in low basis positions in a public 134 00:08:06,680 --> 00:08:10,960 Speaker 2: company for which they worked. And they were really emotionally 135 00:08:11,000 --> 00:08:14,640 Speaker 2: invested in this particular position because they'd worked for the 136 00:08:14,720 --> 00:08:17,720 Speaker 2: company and had done so well over time. They were 137 00:08:17,760 --> 00:08:21,680 Speaker 2: also interested in finding ways to improve their risk and 138 00:08:21,840 --> 00:08:23,800 Speaker 2: manage a taxable exit. 139 00:08:24,000 --> 00:08:25,880 Speaker 1: So in other words, they're trying to do two things. 140 00:08:25,920 --> 00:08:30,200 Speaker 1: They want to diversify away from that concentrated position and 141 00:08:30,320 --> 00:08:33,120 Speaker 1: at the same time not pay a giant tax bill, 142 00:08:33,520 --> 00:08:35,440 Speaker 1: if you know, if it could. 143 00:08:35,320 --> 00:08:38,120 Speaker 2: Be avoided exactly right. So what they did was they 144 00:08:38,600 --> 00:08:42,199 Speaker 2: brought the position to us. We actually built a risk 145 00:08:42,240 --> 00:08:48,360 Speaker 2: aware exposure understanding that company's particular characteristics. We built a 146 00:08:48,400 --> 00:08:52,679 Speaker 2: passive exposure to pair with the name that was underweight 147 00:08:52,800 --> 00:08:58,080 Speaker 2: to similar companies, so that immediately their risk was mitigated 148 00:08:58,160 --> 00:09:02,360 Speaker 2: because of that diversification. And then we started to look 149 00:09:02,400 --> 00:09:05,640 Speaker 2: for tax loss harvest opportunities. When there were losses in 150 00:09:05,679 --> 00:09:08,720 Speaker 2: the market, we were able to take those losses and 151 00:09:08,960 --> 00:09:12,600 Speaker 2: offset positions in the name, selling them down over time. 152 00:09:13,000 --> 00:09:16,480 Speaker 2: We were actually able to do so in twenty twenty. 153 00:09:16,640 --> 00:09:20,240 Speaker 2: Remember they started with a fifty percent position. We were 154 00:09:20,280 --> 00:09:23,600 Speaker 2: able to reduce that to in a short period of 155 00:09:23,640 --> 00:09:28,000 Speaker 2: time about a fifteen percent position net of any. 156 00:09:28,080 --> 00:09:31,480 Speaker 1: Gains, meaning they're not paying a long term or short 157 00:09:31,520 --> 00:09:34,320 Speaker 1: term capital gains taxes on that exactly. And by the way, 158 00:09:34,360 --> 00:09:38,920 Speaker 1: this isn't like I've jokingly described certain tax concepts as 159 00:09:39,360 --> 00:09:43,440 Speaker 1: Wesley Snip's gray. You know, we don't know what the IRA. 160 00:09:43,720 --> 00:09:46,440 Speaker 1: This is black letter law. The IRS is signed off 161 00:09:46,440 --> 00:09:49,160 Speaker 1: on this. All of this is totally kosher and above board. 162 00:09:49,240 --> 00:09:52,160 Speaker 2: Yeah, the positions are at a gain, this particular concentrated 163 00:09:52,160 --> 00:09:55,480 Speaker 2: position as a gain, we're able to take losses to 164 00:09:55,559 --> 00:09:59,120 Speaker 2: offset that and work the position down over time. Now, 165 00:09:59,160 --> 00:10:02,800 Speaker 2: in this instance, because the market movement was so significant 166 00:10:02,840 --> 00:10:04,960 Speaker 2: to the down, we were able to do so in 167 00:10:04,960 --> 00:10:09,040 Speaker 2: a very accelerated fashion. All within the context of that 168 00:10:09,160 --> 00:10:12,079 Speaker 2: calendar year. They got down to about a fifteen percent 169 00:10:12,960 --> 00:10:15,439 Speaker 2: weight of the name. Remember they had started with fifty 170 00:10:15,880 --> 00:10:19,120 Speaker 2: as a percentage of their total liver At that point, 171 00:10:19,160 --> 00:10:24,360 Speaker 2: they decided to liquidate the entire position to move away 172 00:10:24,400 --> 00:10:26,719 Speaker 2: from the risk exposure of that name, and they did 173 00:10:26,760 --> 00:10:29,240 Speaker 2: so with a fraction of the tax consequence that had 174 00:10:29,280 --> 00:10:30,760 Speaker 2: they sold out to begin with. 175 00:10:30,920 --> 00:10:36,040 Speaker 1: So this sounds like this is a sophisticated and expensive technology. 176 00:10:36,559 --> 00:10:39,440 Speaker 1: What are the trading costs like this? How pricey is this? 177 00:10:39,960 --> 00:10:42,720 Speaker 2: So one of the things that's occurred in the market 178 00:10:42,760 --> 00:10:46,680 Speaker 2: is that trading costs have dropped pretty dramatically. 179 00:10:47,080 --> 00:10:49,440 Speaker 1: Practically free at most custodians, right. 180 00:10:49,400 --> 00:10:53,360 Speaker 2: That's correct, that's correct. On our platform, the average fee 181 00:10:53,360 --> 00:10:56,000 Speaker 2: a client is paying, as we've talked about basis points 182 00:10:56,280 --> 00:11:00,440 Speaker 2: twenty one basis points, and so certainly with regard to 183 00:11:01,320 --> 00:11:05,360 Speaker 2: many other options out there, when you're then adding the 184 00:11:05,880 --> 00:11:09,760 Speaker 2: potential tax benefits on top on an after tax basis 185 00:11:09,880 --> 00:11:11,200 Speaker 2: quite attractive. 186 00:11:11,040 --> 00:11:13,800 Speaker 1: I'd say, the very least. So is this for fat 187 00:11:13,840 --> 00:11:16,440 Speaker 1: cats with millions and millions of dollars? Or is this 188 00:11:16,480 --> 00:11:18,600 Speaker 1: for ordinary people? Can I do this? 189 00:11:18,720 --> 00:11:19,200 Speaker 2: Do I need? 190 00:11:20,000 --> 00:11:22,599 Speaker 1: Can I get into this with less than five million dollars. 191 00:11:22,440 --> 00:11:24,480 Speaker 2: Two hundred and fifty thousand dollars er minimum? 192 00:11:24,559 --> 00:11:29,200 Speaker 1: Okay, so not nothing, but not an unreasonable amount of 193 00:11:29,360 --> 00:11:32,199 Speaker 1: dollars to do this. So to wrap up, if you're 194 00:11:32,200 --> 00:11:35,800 Speaker 1: an investor sitting with a big pile of employee stock, 195 00:11:35,800 --> 00:11:40,920 Speaker 1: option plan, equity, founder stock, venture, investment, startup, a sale 196 00:11:40,960 --> 00:11:43,600 Speaker 1: of a business or a house, you're looking at a 197 00:11:43,679 --> 00:11:48,880 Speaker 1: substantial capital gains tax. What matters most to you as 198 00:11:48,920 --> 00:11:54,040 Speaker 1: an investor is your net after tax returns. Direct indexing 199 00:11:54,240 --> 00:11:56,480 Speaker 1: is a really good way to allow you to keep 200 00:11:56,840 --> 00:12:00,360 Speaker 1: the most amount of your gains net of taxes. It 201 00:12:00,440 --> 00:12:03,400 Speaker 1: takes some money, about a quarter million dollars invested in 202 00:12:03,480 --> 00:12:08,559 Speaker 1: a taxable portfolio, but ultimately that can save you big 203 00:12:08,640 --> 00:12:17,600 Speaker 1: dollars on your tax bill. You can listen to At 204 00:12:17,679 --> 00:12:20,959 Speaker 1: the Money every week, finding in our master's and business 205 00:12:21,000 --> 00:12:24,080 Speaker 1: feed at Apple Podcasts. Each week we'll be here to 206 00:12:24,120 --> 00:12:27,599 Speaker 1: discuss the issues that matter most to you as an investor. 207 00:12:27,960 --> 00:12:31,040 Speaker 1: I'm Barry Rittolts. You've been listening to At the Money 208 00:12:31,280 --> 00:12:34,600 Speaker 1: on Bloomberg Radio.