Bill Hortz's picture

[2022’s market volatility after a lengthy bull market brought awareness of the need for better tax management capabilities into focus for advisors and their clients. It was realized that investment strategies that were coupled with tax management could be a differentiating and competitive offering leading more advisors to look at areas like separate accounts. A recent survey by FUSE Research reported that financial advisors say tax management within separately managed accounts (SMAs), with features like tax harvesting, is the most highly rated characteristic and top benefit of SMAs.

Understanding the tax implications of portfolio management, though, is confusing for both clients and advisors, especially when multiple accounts, transfers, and tax harvesting are involved. It has been difficult to get tax information in real terms for the client and using their actual tax situation, instead of using some generalized information not based on the client’s specific situation. Innovation has finally come to this long-standing quandary making it easier for the advisor to use the client’s real tax situation to show results for the entire portfolio as opposed to just one piece of their investment picture, thereby providing a more personalized overall experience for the client.

To better understand the nature and implications of this innovation in portfolio tax management, we reached out to Institute member Dave Gordon, CFA, CPWA, and SVP of Direct Indexing at Vestmark – a provider of portfolio management/trading solutions and outsourced services that enable financial institutions and wealth managers to efficiently manage customized client portfolios and propel them to the next generation of digital investment solutions. We also asked David questions to learn how wealth managers can achieve a competitive edge by expanding their current successful strategies with tax management capabilities through a plug-and-play tax management solution.]


Hortz: Why can conversations about the impact of taxes on client portfolios be difficult for advisors?

Gordon: Advisors shy away from the tax conversation because there is a commonly held view that “we’re not tax advisors” – and it’s true, we are not.  But there is a big difference between providing tax advice and providing tax information and enabling outcomes that help to minimize the client’s tax bill from the portfolio.

Tax information includes things like the differences between long-term gains and short-term gains, the ability to offset realized gains with realized losses, or the difference between qualified dividend income and non-qualified dividend income. A common informational framework allows advisors to ask better questions of clients – and probably get better answers. And connecting that information to explaining exactly what it can mean in real terms for clients’ portfolio outcomes has, historically, been quite manual and/or virtually impossible.

Hortz: How are you making it easier for advisors to talk to their clients about tax implications?

Gordon: We have several ways to help advisors who are using our offerings. One is on-screen help – pop-up definitions or footnotes that explain terms in the advisor portal. We also have educational content and a video library that explains different topics in client-friendly terms. And our investment proposals feature plain-language explanations of difficult concepts so that advisors can feel confident explaining them to clients. 

And finally, the VAST proposal system itself has been designed to illustrate the direct connection a client’s individual tax circumstances and risk scenarios can have on the portfolio. That said, it's important to acknowledge the potential risks and complexities associated with tax management practices. Despite making a good-faith effort to make tax-optimal investment recommendations for investors, of course, there is no guarantee of the effectiveness of tax-efficient optimization methodologies in serving to reduce or minimize an investor’s overall tax liability.

Hortz: How did you design your software technology to solve this problem?

Gordon: Our Advisor Portal is deceptively intuitive, which is another way of saying that a lot of complicated calculations are happening behind simple screens. When an advisor determines their investment selections, for example, the software is building a blended benchmark in the background against which various risk metrics will be calculated. That blended benchmark protects the “sleeve weights” the advisor was seeking across the diversified set of asset classes and investments in the proposed portfolio, and even takes steps to preserve proper diversification within sleeves. 

We took a similar approach in tailoring tax management to each individual investor: instead of asking hard questions like “What are the investor’s current tax rates?”, we ask a set of easier questions: “What’s your estimated taxable income this year?  Where do you live?  What’s your tax-filing status?”  We can use the answers to those questions to suggest this year’s actual State and Federal tax rates for that particular client.

Hortz: Why do you feel this is an important innovation for the industry?

Gordon: Direct Indexing has room for improvement. For years, our industry has operated under a set of simplifying assumptions that make our lives easier but do not provide the best client experience. Many direct indexing providers, for example, assume that every investor is in the top federal income tax bracket and pays no state or local income tax.  That assumption has made calculations easier, but it short-changes the end investor (and, by extension, the referring advisor).

Collecting more accurate investor information – one investor at a time – allows us to build investor-specific investment proposals and tailor our recommendations to provide the best potential outcome for each individual investor.  We have extended that customization to the advisor level, allowing many of our investment management choices and constraints to be configurable at the firm level. We also support multi-asset accounts and can risk-optimize and tax-optimize across multiple strategies in a single account. This takes personalization to an entirely new level, for the advisor as well as the client.

Hortz: How do you address advisors’ fear of offering too much tax information and treading on tax advice?

Gordon: I think advisors should always bracket their tax conversations with phrases like “Please ask your professional tax advisor about this” or “Here’s how you might incorporate this tax principle into your investment decision-making.” Tax is not a topic advisors should avoid though, because it has a significant impact on a client’s ability to accumulate wealth and accomplish their objectives. Again, there’s a difference between “tax advice” and “tax information.” Advisors with lots of tax information at their disposal can prepare clients to seek better tax advice from their CPAs.

Hortz: Any thoughts on how advisors can competitively position themselves by applying this new level of detailed personalized tax information to their client conversations?

Gordon: Death and taxes are not just famously unavoidable; they are also intensely personal. Advisors cannot do much about the “death” part, other than to encourage good estate planning, but they can influence clients’ tax outcomes.  Taking an interest in improving these very personal outcomes elevates an advisor above the simplifying-assumption crowd. It also gives you something to talk about in all markets. 

I published a paper a few years ago titled “The After-Tax Advisor,” and I think that is a good way to position yourself. You might also position yourself as a “Silver-Lining Advisor,” making the most of the tax information available to try to improve each investor’s after-tax returns, and even illustrate the powerful compounding effect that can have, over time, on the growth of the client’s assets.


The Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We operate as a business innovation platform and educational resource with FinTech and financial services firm members to openly share their unique perspectives and activities. The goal is to build awareness and stimulate open thought leadership discussions on new or evolving industry approaches and thinking to facilitate next-generation growth, differentiation, and unique community engagement strategies. The institute was launched with the support and foresight of our founding sponsors — Ultimus Fund Solutions, NASDAQ, FLX Networks, TIFIN, Advisorpedia, Pershing, Fidelity, Voya Financial, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines). 


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