As we approach the end of another banner year in the markets, financial advisors engage in their annual ritual of examining client portfolios for tax-loss harvesting opportunities. While this calendar-driven approach allows for increased certainty of client tax budgets toward year-end, the evolution of financial technology and sophisticated portfolio optimization techniques suggests it's time for a paradigm shift in how we approach tax-aware portfolio management.
Traditional tax-loss harvesting often follows simple steps:
- Identify positions with significant losses
- Consider holding periods
- Execute trades in December to capture tax benefits before year-end
With the manual specification of asset equivalents and drawdown thresholds, this traditional process can be scaled well across a book of business with rebalancing software such as the Black Diamond Rebalancer. But to achieve even more scale and personalization, this procedure can be upgraded such that asset equivalents and drawdown thresholds are dynamic and determined by each client’s target portfolio and tax objectives.
A more sophisticated, model-driven approach to tax-loss harvesting can significantly enhance client outcomes while improving advisor efficiency. By incorporating the factor exposures of a client’s target portfolio, correlations, and systematic monitoring, advisors can transform tax-loss harvesting from an annual event into a continuous portfolio optimization process. This evolution brings several key advantages.
Solving Tax Management with Portfolio Optimization
Modern portfolio optimization tools can quantitatively monitor and measure the trade-offs between tax-loss harvesting opportunities and the portfolio objective. While traditional methods might focus solely on the magnitude of individual security losses, advanced modeling can simultaneously consider factors such as losses, portfolio drift, sector exposure, factor tilts, and investor preferences and constraints.
This holistic view helps ensure that tax-loss harvesting decisions enhance rather than detract from the portfolio's objective.
Unlocking Opportunities with Risk Models
A risk-aware approach can more effectively identify suitable replacement securities by analyzing multiple dimensions of similarity. Rather than simply choosing another security in the same sector, the risk-based approach can consider factor exposures and correlations to maintain desired portfolio characteristics while harvesting tax losses.
By abstracting the process from individual holdings to risk management and portfolio objectives, advisors can more easily and reliably perform tax management at scale.
Scaling Operations with Outcome-Oriented Alerts
Automated monitoring and alerting systems can help advisors scale tax-loss harvesting services more efficiently across their client base. Instead of manually reviewing dozens of security drawdown alerts and related tax lots, advisors can focus their attention on opportunities at the household level that have been pre-screened for both tax savings potential and portfolio impact.
By incorporating filters for tax-sensitive clients or those with lower expected tax rates in the future, advisors can further refine these alerts to those that will have the most significant impact across the client base.
While 2024's strong market performance might suggest limited tax-loss harvesting opportunities, this environment may present an ideal time to upgrade tax management processes. Markets in aggregate are up, but the recent election results have certain themes and exposures down significantly year-over-year. When markets eventually experience their next downturn, advisors implementing systematic tax-loss harvesting frameworks will be better positioned to capture value for their clients while maintaining scalable, efficient operations.
SS&C’s Black Diamond® Wealth Platform team fully supports the variable needs for rebalancing and tax-focused solutions among and within our advisory firm clients. With SS&C ALPS Advisors, a true natively integrated investment management partner, the forthcoming access to portfolio optimization in the platform aims to expand the more sophisticated capabilities of the Black Diamond Rebalancer.
Discover how the SS&C Black Diamond Wealth Platform can support your unique advisory business, request your personal demo, call 1-800-727-0605, or email info@advent.com. Existing clients can receive a free Tax-Aware Optimization or Proposal by reaching out to their Black Diamond Relationship Manager.
