Blog, Financial Planning, Tax Management

Secrets of Wealth Management Professionals

financial planners sitting at table

The world of wealth management can be shrouded in mystery, with industry insiders holding the keys to the secret of financial success. While there are well-known basic principles, like saving money and investing wisely, there are lesser-known strategies that professionals utilize to manage wealth for their clients.

Here are some wealth management secrets that could help optimize your financial portfolio.

Know what’s important…and what’s not

The financial media features market pundits who predict the direction of the stock market, recommend stock “winners,” and try to identify the next “hot” mutual fund manager.

It’s not surprising that many investors believe engaging in these activities is productive and an integral part of wealth management.

Sophisticated financial advisors don’t share this view.

According to Larry Swedroe, a prolific author of financial books, stock picking and market timing have terrible track records.

Swedroe believes that trying to pick individual stocks is built on the premise that the stock market is constantly mispricing stocks, which lacks support.

In addition, research has shown that most actively managed mutual fund managers do not consistently outperform the market by successfully timing or picking stock “winners.”

Rather than trying to pick stocks or time the market, Swedroe advocates for a passive investment strategy that focuses on having a globally diversified portfolio in a suitable asset allocation, using low-cost index funds.

Tax savvy strategies

You’ve probably heard the expression, “It’s not how much money you make, but how much money you keep.”

Sophisticated advisors focus on tax management with the goal of providing their clients with higher after-tax returns.

Tax benefits of index funds

These advisors understand that index funds are often more tax efficient than actively managed funds and may generate higher after-tax returns.

Because index funds track an index, the fund manager makes fewer buy and sell decisions, resulting in less portfolio turnover.
Less turnover means lower trading costs and fewer taxable gains distributions.
Actively managed funds aim to outperform their benchmark index, which requires more frequent buying and selling decisions, often leading to higher portfolio turnover and higher capital gains distributions.

As a result, actively managed funds often generate more taxable income than index funds, resulting in a higher tax bill for investors.

Asset allocation strategies

Investing in index funds isn’t the only way financial professionals can reduce taxes for their clients.

Asset location is a tax-management strategy that involves allocating different investments into accounts with different tax treatments: tax-exempt, tax-deferred, and taxable. By using this strategy, investors can potentially lower their overall tax bill over time.

For example, placing investments that generate a lot of taxable income, like bonds, in tax-deferred accounts (like 401[k] plans) can defer the interest generated from being taxed (at ordinary income rates) until it is withdrawn, which can be many years down the road. In the interim, principal, and income remain invested and potentially increase in value.

Investments that generate little taxable income, like stocks, can be held in taxable brokerage accounts. These investments are only taxed when you earn dividends or interest or sell them. They are taxed at lower capital gains rates if you have owned them for over a year before you sell.

A tax-savvy financial advisor may advise clients to invest in tax-exempt accounts like Roth IRAs, Roth 401(k)s, and Roth 403(b)s. As long as applicable rules are followed, no taxes will be due when withdrawals are made from these accounts.

Understand your financial biases

A critical component of sophisticated wealth management is understanding the role emotions and cognitive biases play in financial decision-making. Behavioral finance is a field that examines the psychological factors that influence investors’ decisions and aims to help them overcome these biases to make better choices.

Common financial biases include:

  • Recency bias (overly influenced by recent events);
  • Loss aversion bias (why the pain of a loss is far more impactful than the pleasure of a gain);
  • Confirmation bias (Giving greater credence of evidence that validates our pre-existing beliefs);
  • Familiarity bias (Demonstrating a preference for investing in companies known to them);
  • Anchoring bias (overreliance on the first piece of information we are given about a topic. ):

Wealth management professionals attempt to identify and mitigate the effects of these biases. They can help their clients deal with them by incorporating behavioral finance principles into their practice.

By helping clients understand and overcome their financial biases, wealth management professionals can help them make more rational, informed decisions about their portfolios.

At Allied Integrated Wealth, we provide tax-savvy, comprehensive investment advice to our clients.

Let us help you create a comprehensive, customized financial plan.

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