January 3, 2024
Advisor-Managed vs Outside-Managed Accounts
Most clients have investment accounts in each of the three major tax buckets: tax-deferred (ex. 401(k)), tax-free (ex. Roth IRA), and after-tax (ex. Brokerage account). Due to the different tax statuses, each account type “behaves” differently.
When investors save adequately across these accounts, there are a myriad of benefits. From a tax management standpoint, a financial advisor can help design a tax efficient withdrawal strategy. With that in mind, there are also drawbacks to investing when there is a lack of coordination across these different accounts. This often happens when accounts are managed outside of one’s advisor-managed accounts.
At a high level, advisors are licensed professionals with access to tools and services that the general public typically does not have. Financial advisors can create a consistent investment strategy that should be integrated across client accounts. At the individual level, this is just one less thing for each client to navigate on their own in the midst of their own personal and professional responsibilities.
At a more detailed level, fully integrated advisor-managed accounts allow for more accurate management of capital gains, including:
- Realizing short-term losses used to offset income tax instead of capital gains tax.
- Accurate management of realized gains to prevent unnecessary tax payments.
- More efficient tax bill for Roth conversions due to proper management of realized gains when using brokerage assets to pay tax on conversions.
While consolidating all of your investment accounts with one advisor can be time consuming, that process is largely offset by the potential lack of coordination between advisors which can complicate financial planning goals and prevent plans from being executed. As more and more investors are switching their investments to exchange traded funds (ETFs) from mutual funds, many still hold mutual fund shares in their accounts outside of Rockbridge. Actively managed mutual funds tend to have higher expense ratios and are less tax efficient than exchange traded funds. For example, as mutual fund shares are redeemed (outflows) at a greater rate than shares are purchased (inflows), fund managers will realize gains inside the fund portfolio, which passes capital gain costs onto the investors.
- Consider consolidating accounts with one manager.
- If mutual funds are held in qualified accounts, reinvest mutual fund shares into ETFs with no tax consequences.
- Turn off “auto-reinvest” of dividends of mutual fund shares.