Romantic Moment on the Beach

Romantic Moment on the Beach

“I want to know what I need to do to pay no taxes.” This desire was recently expressed by a client, and it is an often-voiced goal of many. The desire to pay a small amount of taxes is a worthwhile goal. Keep in mind, however, it is just one part of your overall financial picture.

Focus on Big Picture to Reduce Tax Burden

The goal to reduce taxes should be reviewed when considering portfolio allocation and specific investment choices. The payment of taxes creates a negative drag on the performance of investment choice and slows the progress towards financial goals. This “cost” can be controlled at some level and should be considered; but taxes are only one type of cost incurred while reaching financial goals.

Still, some investors becomes so focused on tax payment, they overlook the big picture. The after-tax performance, whether absolute or relative to a benchmark, is a more appropriate measurement. Too often, an investor may be tempted to invest in a vehicle less likely to meet his or her goals simply to avoid the payment of taxes.

Our desire to avoid tax payment is no secret; and many investment products are designed to appeal to this desire. Unfortunately, many of these products are complicated, which increases costs or becomes too constricting to deliver the performance of a “simpler” investment tool with sound tax planning.

Considering a portfolio as a whole, rather than individual pieces, allows the investor and his advisor to allocate investments in a tax-efficient manner. For example, the rules governing REITs (real estate investment trusts) typically require a high payout of cash received, which typically is not taxed efficiently to the average investor. However, historically, this asset class has provided diversification benefits to the overall portfolio. The choice to avoid this asset class due to the tax burden may not be a wise decision. Rather than avoid the asset class entirely, a more prudent choice may be to allocate this portion of the portfolio to a tax- deferred account.

There is one guaranteed way to pay no taxes – make no money! Uncle Sam taxes income and capital gains. If the investor has neither, it is unlikely they will pay taxes. This concept may appear extreme, but helps put the “I want to know what I need to do to pay no taxes” comment into perspective.

Legally minimizing your payment of taxes is a financially-wise decision. Yet, choosing an investment vehicle that provides a lower likelihood of achieving your financial goals simply to avoid tax payment may not be such a wise decision. Take the time to review all the pertinent aspects of your investment decisions prior to investing. Be sure you understand the investment choice before committing money to it. If you need assistance with that review, please contact your financial advisor.