In recent years, investors have been fortunate to experience strong returns from equities. With the S&P 500 being up about 70% from this same point five years ago, there’s a lot for investors to be happy about. While being content with a surge in asset values, many investors are facing tough decisions on how to free up liquidity in their taxable brokerage accounts without being hammered by capital gains tax. This brings up the question, how can I free up liquidity while remaining true to my desired asset allocation and limiting capital gains tax?

Let’s imagine an investor invested $1,000,000 into a 50/50 stock/bond portfolio. Since making the investment, stock and bond market returns have moved the account’s asset allocation as detailed in the right side of the table below.

Suppose this investor needs to raise $50,000 of cash for an unexpected expense. If looking to stay true to their 50/50 stock/bond asset allocation, it would only make sense to sell $50,000 of the U.S. Equity Index fund due to the fund’s 3% overweight position relative to the 50% asset allocation target (highlighted in yellow). By doing this, they will recognize capital gains of about $6,180. Depending of the state of residence and federal income tax bracket, this could cost the investor about $1,200 (assuming 15% federal, 5% state capital gains tax rate) when time to pay taxes.

One way D3 can add value to clients is through integration of qualified retirement accounts into a client’s overall portfolio. By adding tax qualified accounts into the picture, an investor can gain access to greater flexibility when rebalancing a portfolio with respect to capital gains tax.

Through utilization of a third-party data integration software, D3 can effectively bring tax qualified retirement assets into our holistic portfolio management service. Imagine this same investor has funds held away in an employer 401k account. In the 401k account let’s assume the investor has $500,000 invested in the same 50/50 stock/bond split. With this being the case, the investor could afford to sell out of the U.S. Bond Index fund in their taxable brokerage account at a loss, avioding about $1,200 of capital gains tax associated with the sale of the U.S. Equity Index fund.

This can be done through utilizing the tax benefits associated with qualified accounts. As the investor sells out of the U.S. Bond Index fund in their taxable account to avoid capital gains tax, they can rebalance their qualified accounts to ensure their entire portfolio is still in alignment with the desired 50/50 stock/bond asset allocation.

While this scenario is an over simplified example of what D3 does for its ongoing asset management clients, it gives an idea of the tax alpha D3 can add as portfolio managers. If you find yourself facing a similar situation or are looking to develop a plan to divest from a highly appreciated and concentrated position, D3’s tax planning and portfolio management services may be a good fit for you!

If you have any questions about the strategies being demonstrated here or are looking for a consultation, please give our office a call at (312)526-3680.

—Dan Crowley