Clients want more money. They want growth or income or preferably both, thankyouverymuch. In every case, they give their advisor a fistful of dollars and expect two fistfuls in return (hat tip to Clint Eastwood). Rare is the client that asks only for the same number of dollars to be available several years after hiring an advisor.
Advisors typically design a portfolio of assets intended to produce more dollars at some point in the future than the client started with. The ability to successfully generate excess return over a stated benchmark produces investment alpha. A positive alpha of 3.0, for example, represents a return three percentage points higher than the benchmark over a specific timeframe. This is quite a challenge even for the best advisors. It requires them to be right…a lot.
However, there is a different type of alpha that can be planned for, calculated in advance and achieved consistently. Such is the nature of tax alpha. Tax alpha is created when a particular planning strategy results in a reduction of taxes owed. It provides the same net result as investment alpha, namely, more money in the client’s pocket.
Did you know Benjamin Franklin was the first known proponent of tax alpha? His quote “a penny saved is twopence dear,” later updated into modern English as “a penny saved is a penny earned,” is directly on point. A penny saved in tax is just as good as a penny earned from investment performance. One might contend that Mr. Franklin was speaking against frivolous consumer spending, but I suspect he would equally advise against overspending on taxes as well.
A good advisor will sharpen up on advanced tax planning strategies as much as they will on the latest investment information. This is especially pertinent in 2012 to help clients limit the cost of pending tax increases slated for January 1, 2013. Increased tax costs are akin to investment losses in a portfolio while tax savings are akin to investment gains.
One example of how to add tax alpha for clients contemplating wealth transfer strategies can be found in our report titled “Waiter, There’s a REIT in my GRAT!” posted in the Education & Resources section of this site. And pick up a copy of our book, KEEP IT! Advanced Tax Strategies for IRAs, for many ideas on how to provide significant tax alpha to retirement accounts. Stay tuned for many more updates and ideas from Jagen™ throughout the rest of the year.
Tax mitigation strategies can provide “guaranteed” returns that are only dependent on following the rules. Geopolitical activities, investor emotions, market movements and corporate profits have no bearing on returns generated from tax alpha strategies. Wise is the advisor that can generate investment results via tax savings even if a portfolio is flat. Ben would be proud.
Author: Joe Luby, CFP®
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