Strategic Tax Planning: Kickstart the Year With Direct Indexing

Executive summary:

Initiate the year with direct indexing, encompassing tax planning, personalized investing strategies, rejuvenating sidelined cash, and navigating concentrated stock positions or financial windfalls.
Commencing early tax-loss harvesting though direct indexing sets the stage for potentially increased after-tax returns and reduced tax burdens throughout the year.
These questions and scenarios enable advisors to unearth potential opportunities within direct indexing.

Over the past year, I’ve been sharing tips and strategies on direct indexing.

January isn’t just about resolutions; it’s a great time to set up financial strategies. Although—when it comes to taxes, many investors aren’t actively managing them year-round. But here’s the scoop: the real game-changer is starting early. Kicking off tax-loss harvesting at the start of the year unlocks nearly 11 months for harvesting potential losses. Why does this matter? Well, it’s about potentially dodging hefty taxable gains from selling securities and opening up more avenues for you to hit your financial targets. Opting for a direct indexing portfolio in January buys you a whole year to balance gains with those harvested losses. Delaying this strategy limits the window for goal achievement—a key factor that often gets overlooked.

How does direct indexing help with tax planning?

Direct indexing allows for greater control over individual stock positions, enabling tax-loss harvesting to offset gains strategically. By selectively selling losing positions, investors can reduce taxable income and potentially increase after-tax returns.

At Russell Investments, we’re fans of using direct indexing portfolios for smart tax planning. For example, investors eyeing future business or property sales might consider investing in a direct indexing portfolio early to kickstart the tax-loss harvesting process. This strategy amplifies the potential tax offset upon eventual realization of taxable gains.

Let’s dig deeper with some focused questions and scenarios that can help unveil specific direct indexing opportunities.

Uncovering direct indexing opportunities: Questions for advisors

How close are your clients to significant life changes or retirement that might trigger a financial windfall?

What sources do they anticipate these future windfalls to come from, and when?

How many of your clients are looking for personalized investment strategies that align with their values?

Have you considered leveraging direct indexing to get sidelined cash back into the market?

How much do your clients know about direct indexing? Can you illustrate the benefits of direct indexing to manage potential tax liabilities or maintain tax budgets within limits? (Hint: We’ve got an investor-friendly resource for you to leverage, Unleashing the Power of Direct Indexing).

Managing future windfalls

Many high-net-worth individuals foresee substantial gains from business, property, or large stock sales down the line. However, the planning often falls short. This is where Direct Indexing emerges as a potential strategic solution. With direct indexing, advisors can proactively manage client portfolios to help minimize capital gain taxes by strategically harvesting losses, offsetting gains, and implementing tax-efficient trading strategies. Starting this process early in the year provides adaptability to market shifts and evolving financial landscapes.

Addressing mutual fund tax challenges

For those facing capital gain taxes from mutual fund holdings, direct indexing offers an enticing alternative. Unlike mutual funds, these strategies encompass separately managed accounts, eliminating the need for capital gains distributions—a significant advantage for those seeking to minimize tax liabilities.

Tackling concentrated stock positions

Many high-net-worth investors hold concentrated stock positions accumulated over years. Often overlooked, these positions might sit unmanaged, posing financial risks and compliance liabilities. Direct indexing can step in by offsetting annual capital gains taxes until the concentrated position diminishes. Alternatively, a strategic reduction plan over several years can be executed, offsetting gains with tax-loss harvesting to help minimize associated taxes.

Reintroducing cash-held clients to investing

Many financial advisors face the challenge of guiding clients with substantial cash reserves back into the market. Direct indexing emerges as a potential tool in this pursuit, offering tailored solutions that could resonate with clients seeking personalized strategies. This approach not only helps mitigate tax liabilities but can also instill a sense of confidence in clients by offering a hands-on, transparent investment experience.

Encouraging transparency of securities elsewhere

By expressing genuine interest in understanding the entirety of your client’s portfolio you can emphasize the importance of consolidating information for a holistic financial strategy. Questions centered around individual securities and ETFs held elsewhere should aim to uncover gains, losses, and overall patterns, ensuring a clearer picture to tailor more effective tax-efficient solutions and investment strategies. This transparency not only helps strengthen the advisor-client relationship but also allows for a more comprehensive and informed financial planning approach.

Uncovering direct indexing opportunities: Questions to ask your clients

Are you expecting any significant financial windfalls, like the sale of property or the sale of a business, in the foreseeable future?

Do you have mutual fund holdings that are generating capital gains taxes that could be mitigated through an alternative strategy like direct indexing?

Do you hold a concentrated stock position, possibly accumulated through equity grants or stock options, and need a tax-efficient plan to manage it?

Are you looking for a personalized investment strategy that aligns with your financial goals, risk tolerance and preferences while minimizing tax liabilities?

Would you be open to exploring options that could help strategically manage tax liabilities tied to your investments?

Bottom line

Start the year right—uncover the power of direct indexing to help elevate strategic tax planning for your clients in the year ahead.

Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Direct indexing is offered through Russell Investments’ Personalized Managed Accounts (PMA) program.

Personalized Managed Accounts (“PMA”) is a program of Russell Investment Management, LLC (“RIM”) and offers customized portfolio management services.

Each Personalized Separately Managed Account is a product of Russell Investment Management, LLC (”RIM”) and is offered through PMA. It represents a composite of model portfolios provided by RIM, in which each composite reflects model portfolios of RIM and third-party investment advisors selected by RIM. When the model is implemented, PMA is a separately managed account program of individually owned securities that can be tailored to meet an investor’s investment objectives. RIM partners with external third-party money managers to offer diversified, single or multi-asset managed accounts that can be customized to the investor’s investment objectives, circumstances and preferences, such as (but not limited to), market exposure, risk management, tax management, environmental, social and governance considerations, and return objectives. Excluding any allocations to pooled investment vehicles, if any, each investor’s account is managed separately from other investor accounts, allowing for a personalized experience to deliver unique investment outcomes.

The decision to use PMA in investors’ portfolios and related investment advice are provided through financial advisors and other financial intermediaries that are independent of RIM and its affiliates. Investors should consult with their financial advisor to determine which services and programs are appropriate to meet their investment objectives.

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