How should I switch from active to passive management in a taxable account?
I would like to switch my taxable account from active to passive management. I plan on utilizing a long-term buy and hold strategy with combination of diversified bond and equity index funds. I have about $230,000 to move. How can I reduce my tax burden while shifting assets between mutual fund companies?
Even with a stock and bond combination, have you stress tested the allocation to see how much you can lose in a bear market? Look back to 2000 - 2002 and 2007 - 2009 and see how your projected allocation did. Does it hold up well enough to go with, and stick to a buy and hold strategy?
As far as repositioning any portfolio from one strategy to another. Timing is everything. Moving to a buy and hold immediately prior to a major market sell off could be devasting. By following the steps below you will spread out your sells and buys, and lower the risk of changing course at a bad time.
In investing it is said that fundamental analysis tells you what to buy or sell, technical analysis tells you when to buy or sell. In other words I would not just sell everything at one time and rush into your new strategy. You are now looking at realatively short term trading strategy. First let your winners run, no reason to rush out and sell. You can follow the the stock price up with a stop loss order that should trigger with a set back. For example if a stock is at $80 per share, set a stop loss at $75. That way if the stock continues up you continue to gain, and lock in a $75 price if the market reverses. If the stock goes to $85 raise your stop loss to $80. (Understand stop loss orders - they are not guarantees that you will get your stop price.)
Go to any number of web sites and compare a chart of your holdings one at a time to the security you will buy with the proceeds when it sells. This doesn't need to be rocket science, but if what you own is doing better than what you'll be buying, don't switch. When its momentum falls below the new candidate sell and switch.
Sell everything now that has a loss to offset the gains from your other holdings.
Taxes aren't the main issue, its maximizing your gains. No one has ever gone broke taking a profit.
It is going to be difficult to do if not impossible without incurring significant capital gains given the overall market strength, but in the long run you still may come out ahead. To spread your tax liability out you could liquidate half now (2017) and then the other half in 2018 so it is spread over two years. Also, you might be able to generate some tax losses next year to offset the gains. Why you may still come out ahead is the fact tha passive funds can have expenses a tenth of an active manager and over time that discounted fee might make up for the tax hit. It is impossible to know for sure without more details like your expected holding periord and individual tax situaiton, but definately consider those two factors.
As a general rule don't let a tax liability keep you in a investment you are not happy with. I hope this helps. Good luck.
Without knowing anything about your specific positions and their respective capital gains/losses the only thing you can do to minimize the tax consequences of switching from Mutual funds to a passive instrument (index fund or ETF), is to use the losses to offset gains. You could also spread the taxes across this year and the next or slowly integrate your strategy over a number of years if you have significant gains.
However, it's inevitable that Uncle Sam will collect at some point, trying to determine a year you may be in a lower tax bracket, or have significant losses to use against gains can be a strategy, but it shouldn't stop you from altering your investment strategy if you believe it's going to benefit you more in the long run.
You are asking a good question and thanks for asking it. You don't need to move the assets into a different account, but what you should consider is analyzing the positions to see where there are losses and if those assets are positions you continue to believe in. If you don't think they are high quality, and have losses, you sell those assets and then redeploy the capital into index funds of the different asset classes. In this way, you gain the tax shield of losses, eliminate holdings which have not performed, and can deploy the capital into passive instruments. I hope this helps answer your question.
Yale Bock, CFA
Y H & C Investments
'Buy and Hold'? Really? You are obviously more worried about fees than performance aren't you? Here is the deal ... Some passive accounts do well some don't. Some active accounts do well some don't. We use active and passive and stocks and bonds and we rebalance and we rotate when needed. Why? Because nothing wins year after year. Each position you own will lose money, and will have a bad year while some positions will do well. The key is to have more winners than losers right? The challenge is for all of us is that you don't know which one positions will and/or won't perform in a given year. The key to all of this, especially in a Taxable account, is of course to be as tax efficient as possible and yes ETF's are generally more so than Mutual Funds, but isn't your priority to obtain the highest net rate of return possible with the least amount of risk? So focus on a balanced approach between passive, active, stocks and bonds. Rebalance when your risk starts to change more than you can stand, and rotate the asset classes because not all bonds are equal and not all equities are either, and drop the 'Buy and Hold' mentality. Remember this, the S&P 500, even after the banner year of 2017, has still earned less than an average of 5% per year since the year 2000, so what does that tell you?