Norman M. Boone, Founder and President, Mosaic Financial Partners
Many of us have investments scattered among multiple money managers. If they are not working together, a lack of coordination among those managers could be costing you a lot of money, says Norman M. Boone, founder and president of Mosaic Financial Partners Inc.
“If all of your accounts — trusts, 401(k)s, IRAs, individual accounts, joint accounts, etc. — are under one broker, that person will have a clear picture of everything that is going on across those accounts,” says Boone. “Most investors have no idea how much it may be costing them to have different parts of their portfolio under different managers. This is especially true for the taxable part of your portfolio.”
Smart Business spoke with Boone about why one hand needs to know what the other is doing and how to find an investment adviser who can maximize the tax advantages across your accounts.
How can having accounts across different managers cost investors money?
Let’s say you have $500,000 to invest, and your broker puts your account with three different account managers who are buying individual securities. Typically, they do not communicate with one another about their trades and holdings. This can create a couple of problems. The first issue is that they may be investing in many of the same securities; instead of decreasing risk through diversification, you instead get more risk due to the overlap.
Another pitfall would be if your three managers all avoided a particular industry, for example, the oil industry. The empty places in your portfolio further defeat your desire to diversify. Most managers manage what they are familiar with, and if they are not familiar with oil, or international markets, or emerging markets, for example, that could leave holes in your portfolio.
Both of these problems are caused by the failure to have someone seeing the whole portfolio, to make sure all the bases are covered and that there is no overlap. The lead adviser would make sure there is exposure to large and small cap U.S. stocks, large and small cap international stocks, emerging markets, bonds, real estate, etc.
How could a lack of coordination among managers negatively impact an investor’s tax situation?
According to the ‘wash sale’ rule, if you sell a security at a loss, you can only make use of that loss for tax purposes if you do not buy that same security during the 30-day period before or after the sale. In other words, you lose the tax advantage available when you have a loss. For example, if you sell a stock at a loss and, within 30 days before or after that sale, you also buy that same security, the tax code forbids you from making use of any loss you may have incurred on the sale of that stock.
The rule becomes important in a portfolio that’s being managed by multiple managers. For example, say you have Manager A and Manager B, both of whom oversee a part of the portfolio. Manager A likes IBM and owns the stock in the portfolio. Manager B doesn’t own it yet, but he likes it. Manager A then sees a better opportunity, sells the stock, and assumes the loss on the sale. He thinks he’s helping the client and saving him some tax dollars on the loss. But Manager B, operating independently, buys IBM 20 days later, eliminating the tax saving opportunity created when the stock was sold at a loss.
If there’s no coordination between those managers, the result could be very costly.
How can an investor avoid this issue?
Find an organization that will manage your money in a more coordinated fashion. That firm should be managing all of your accounts, so it knows what is being bought and sold across the portfolio and can make sure someone isn’t buying something that was just sold previously by someone else. This coordination is important if you want to be able to take full advantage of tax laws, and if you want your portfolio to be properly diversified.
Losses can be carried forward forever, until they are used by the taxpayer. As the market returns to strength, having losses ‘banked’ can result in significant tax savings for your portfolio.
What questions should an investor ask when looking for a broker?
Beyond the basic questions addressing how money is managed, questions you might ask include: Do you do tax loss harvesting for my individual portfolio? With separately managed accounts, the manager doesn’t typically know who the clients are and just manages the money without considering the tax consequences for the individual client — and sometimes without even knowing who the client is.
Other questions to ask: How do you coordinate with other managers? How do you manage the wash sale rules to ensure maximum benefit? When managing money, do you take into account individual tax needs? How many clients do you have?
If brokers have 1,500 clients, they may invest in the best small cap stocks, but it’s impossible for them to individually manage the tax needs of each of their clients. You need to find an adviser who manages with that objective in mind, who is sensitive to the costs and considers the tax consequences that reflect your situation, not someone who is just managing money the way he or she wants to manage it.
Norman M. Boone is founder and president of Mosaic Financial Partners Inc. Reach him at (415) 788-1952 or [email protected]