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WHAT ARE TAX HARVESTING AND TAX ALPHA OVERLAY STRATEGIES

Our investment strategies are aimed at improving portfolio returns through sound tax management. We strategically harvest stock losses for tax deductions by selling depreciated stocks as opportunities occur. Whenever the stock market goes down, investors get frustrated. But there is a light in an otherwise gloomy situation, the option to bolster after-tax stock returns through a concept called tax-loss harvesting. Through opportunistic tax-loss harvesting, you can increase your returns indirectly especially early on in a portfolio’s life. This strategy, described below, provides a means to receive extra returns in order to maximize wealth.

INCREASE AFTER TAX RETURNS

Quantum trading strategies enable us to identify trades that can improve their tax position.

Realize a short-term loss before it becomes long-term.

Since the tax rate for short-term gains is significantly higher than that for long-term gains, it is often wise to realize losses on lots before they become long-term holdings, thereby lowering short-term gains. In contrast, waiting for a winning position to become a long-term holding allows investors to take advantage of the lower tax rate. The tax savings can be significant. We set alerts to monitor investor’s positions in their accounts that are approaching long-term status, displaying market value and current gain/loss against that value.

Identify investments for the “Double Down” strategy.

If the long term fundamentals of company are still favorable but there is exogenous factor that causes unwarranted short term drop in the value of the stock, we implement a “Double Down” strategy. We take positions that are currently in a deep losing state, and double their holdings in them. After waiting 31 days to be outside the wash sale window, those shares are then sold at a loss. This strategy allows us to recognize losses for tax purposes without losing our stake in the position.

Sell partial positions using Specific ID.

Many investors fail to maximize the benefits of selling specific lots. If you hold multiple lots of the same security selling only part of the position, without specifying which part, will result in FIFO accounting (First-In, First-Out). However, in most instances it is wiser to sell shares that have the highest unit cost, thereby minimizing gains and the tax burden. Even mutual funds can be sold using Specific ID rather than FIFO or Average Cost.

Use “Sell Grades” to sell optimal lots first.

We grade the tax consequences of selling your investments and rank them accordingly. The higher the “Sell Grade” value, the more favorable the trade is from a tax standpoint. We assign a “Sell Grade” to each holding and then rank them from highest Sell Grade to lowest Sell Grade.

– A Sell Grade greater than 1.0 will save you tax dollars.
– A Sell Grade of 1.0 is neutral and has no tax impact.
– A Sell Grade less than 1.0 will cost you tax dollars.
Our Sell Grade is derived from a proprietary algorithm that considers each tax lot’s adjusted cost basis (i.e. the original cost basis adjusted for all wash sales and/or corporate actions); current holding period (i.e. long-term or short-term); current market price; and most importantly, your personal tax rate and previous realized gains/losses which include the character of those gains and losses. In this way, our Sell Grade is customized to each individual’s portfolio and tax situation.

Recognize losses
The IRS allows investors to write-off a maximum of $3,000 in losses each year. With our tax optimization tool, we enter their carryover losses to determine the impact of their gain/loss.

Example: Imagine that on the first day of any given year you invest $100,000 in the U.S. stock market via an exchange-traded fund (ETF), like SPDR S&P 500. Let’s assume this ETF trades off by 10%, falling to a market value of $90,000. Rather than feeling sorry for yourself, you can sell the ETF and reinvest the $90,000 back into the stock market.

Although you are keeping your market exposure constant for IRS tax purposes, you just realized a loss of $10,000. You can use this loss to offset taxable income which leads to incremental tax savings or a bigger refund. Since you kept your market exposure constant, there really hasn’t been a change in your investment cash flow, just a potential cash benefit on the tax return.

Now let’s say that the market reverses course and heads north, surpassing your initial investment of $100,000 and closing out the year at $108,000, yielding the average 10% pretax return when adding a typical 2% dividend yield. For ease of calculation, let us assume that your marginal tax rate is 50%. Had you done nothing except buy-and-hold in the aforementioned scenario, you would have an after-tax return of 9% represented by an 8% unrealized investment gain plus a 1% dividend gain (2% dividend less 1% paid in tax to the government due to a 50% marginal tax rate).

However, if you sold and replaced your stock market position (‘harvested’ the tax loss), you would also have a loss of $10,000 that you can use to offset some ordinary income or other taxable gains from other areas on your tax return. At the assumed marginal tax rate of 50%, this would be worth $5,000 in income tax savings or another 5% return on the original $100,000. Thus, your net-net after-tax return would now be 14% (9% + 5%).

LIMITATIONS

There are some limitations on this activity. Let’s take a closer look at a few of the limitations and regulations surrounding your taxable gains.

IRS Regulations

First, the IRS won’t let you simply buy an asset and sell it solely for the purpose of paying less in tax. Thus, on Schedule D of the 1040 tax form, the loss will be disallowed if the same or substantially identical asset is purchased within 30 days. This is called the “wash-sale rule.”

As a counter to this, a similar asset of high correlation (but cannot be “substantially identical”) may be made to keep the market exposure constant if you don’t want to wait the 30 days. Correlation is the key here, as many assets move up and down together almost in tandem. Replacing the SPDR S&P 500 with another U.S. ETF, like SPDR Dow Jones Industrial Average would get you almost the same market representation.

Individuals everywhere are concerned about our country, the world, its people, and the environment. For these and other reasons, more people are investing their money to get back more than just a monetary return on their investment. Many are investing to make a positive impact in our country and around the world, as well as to feel that societal concerns should be made an important part of their investment focus.

WHAT IS SOCIALLY RESPONSIBLE INVESTING?

Socially Responsible Investing (SRI) is sometimes referred to as “sustainable”, “socially conscious”, “mission,” “green”, or “ethical” investing. In general, socially responsible investors are looking to promote concepts and ideals that they feel strongly about.

The SRI approach is to invest in stocks and bonds from those companies, counties, or municipalities that promote certain actions, or eschew those which participate in offending actions. It is not unlike the carrot and the stick premise; you reward those that you agree with by investing in their companies (the carrot), and avoid buying shares of those companies that offend your core values (the stick).

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