Seemingly every asset class delivered positive performance in March. In a world awash with gains, how do we act tax-efficiently? In this piece, we briefly summarize March in the markets and describe our approach to tax optimization.

March 2024 Market Performance

Stocks kept rising, as US and international stocks returned +3.22% and +3.29%, respectively [1].

Major bond indices were positive, with the Bloomberg US Aggregate, Bloomberg Global Aggregate Ex-U.S., and Bloomberg Municipal Bond indices returning +0.92%, +0.24%, and +0.00%, respectively [2].

Against the odds, US leading economic indicators continue reclaiming their losses, meaningfully reducing the probability of a recession this year [3]. This is especially impressive when contrasted with Europe’s low growth [4]. Also, the US Federal Reserve indicated minor change in its plans to reduce interest rates, despite a rise in inflation [5] [6].

Spotlight on: Tax-Efficiency

‘Tis the season for taxes, and we at KLR Wealth would like to remind you how we are working year-round to make it jollier (less painful). We strongly believe in integrating tax ramifications into our investment decision-making process - here are a few of the ways we do so:

Investment Selection

Our taxable investment models predominantly feature low turnover mutual funds, exchange-traded funds (“ETFs”), and separately managed accounts that hold individual securities. We prioritize these types of funds because they generate lower taxable distributions and capital gains while offering more predictable returns [7].

For appropriate clients, usually those in higher tax brackets, we invest in high quality municipal bond funds. The interest on municipal bonds is free of federal taxes, giving them a significant natural advantage. Municipal bonds are also exempt from state taxation when they are issued by the taxpayer’s resident state or the federal government and its agencies.

Municipal bond tax treatment is one of many important factors we look at, but it is not the only factor. We also review credit quality, interest rates, yield, duration, and whether the bond is callable. We tend to utilize a diversified national bond portfolio, supplementing with state tax-free bonds where warranted. In addition, we regularly monitor yields of the municipal bond market and its taxable competitors – as we discussed in our January 2024 Monthly Market Update – and we actively capitalize on valuation anomalies.

Trading

We trade our client accounts to maintain portfolio diversification and facilitate cash flows, and we execute these trades with great consideration of taxes. We seek to maintain low turnover for the reasons previously mentioned, we may sell specific lots that minimize short-term or overall gains, and we rebalance only once per year unless otherwise warranted. We craft our rebalancing schedule by analyzing our model portfolios current positionings, back-testing results, and third-party studies [8].

Additionally, we may implement tax-loss harvesting [9] if markets present us with the opportunity. When volatility is high, this strategy may allow us to reduce tax liability and buffer net worth loss for our clients. Tax-loss harvesting involves careful implementation; selecting the correct substitute security and trading optimally requires expertise when markets are moving fast.

Asset Location

Our primary focus is our clients’ total portfolios and goals - each account contributes to the whole financial plan. By adopting this holistic view, we can benefit from “asset location”: placing each portfolio piece in the most suitable account. For example, Roth IRAs are completely tax-free in most cases, therefore, we often tilt these accounts towards higher risk/higher return to maximize the pool of tax-free assets over the investment horizon. For tax-deferred accounts, we often tilt in the opposite direction, knowing their eventual value is likely to be reduced by taxes. All asset location decisions are made with our clients’ financial and personal goals in mind.

Withdrawals

For clients withdrawing from their portfolios, we use strategies that seek to reduce the tax burden. We select the favorable account(s) and positions to sell from after analyzing their effects on the client’s financial plan. In some cases, we can avoid taxes entirely; for example, if a client is withdrawing money to donate to charity, we often recommend gifting appreciated positions thereby avoiding potentially large capital gains. If they are required to take minimum distributions from their retirement accounts, a Qualified Charitable Distribution may be recommended.

Looking Ahead

Despite their potentially enormous value, the benefits of tax-efficiency are not reflected on a quarterly performance report – the industry reporting standard remains gross of taxes. Some choices, such as buying municipal bonds with lower yields, will likely reduce stated performance. Nevertheless, we will always maximize our clients’ chances of success in any way possible; we focus on the long-term, the big picture, and meaningful performance.

If you would like to know how our focus on tax efficiencies affects your portfolio, please contact us, we’re here to help.

¹ Eaton Vance: The BEAT, April 2024, slide 28

² Eaton Vance: The BEAT, April 2024, slides 20, 24

³ The Conference Board: US Leading Indicators

⁴ Vanguard: Vanguard Perspective: March 27, 2024

⁵ CNBC: Fed holds rates steady and maintains three cuts coming sometime this year

⁶ J.P. Morgan: Guide to the Markets, 2Q 2024, As of March 31, 2024, slide 50

⁷ Livingston, M., Yao, P., Zhou, L..: The Volatility of Mutual Fund Performance, Journal of Economics and Business, Volume 104

⁸ Vanguard: Rational Rebalancing: An Analytical Approach to Multiasset Portfolio Rebalancing Decisions and Insights

⁹ Investopedia: Tax-Loss Harvesting: Definition and Example

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not consider any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. This communication may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.

Diversification does not ensure a profit or guarantee against loss.

KLR Investment Advisors LLC (“KLRIA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where KLR Investment and its representatives are properly licensed or exempt from licensure.