If you grossed an 8 percent return and netted 7 percent after tax, is that better than grossing a 14 percent return and netting 7 percent? All things being equal, the 8 percent gross return is going to be better because it assumes you took less risk to get the same net return. Normally the goal is to get the highest rate of return with the least amount of risk. I am going to change that thinking and instead say, “Your goal is to get the highest NET AFTER TAX rate of return with the least amount of risk.”
The realistic belief is that all investment markets are considered efficient. The definition of an efficient market is that over time it is next to impossible for a market timer to determine the best in and out opportunities. Twenty years ago, most studies pegged the chances of your money manager out-thinking the markets at less than 14 percent. In recent studies that number has been lowered to less than a 1 percent chance of your advisor or mutual fund out-maneuvering the markets.
If these studies are true, then how do you get better than average returns without taking more risk? Enter the new world of GAMMA. GAMMA focuses on the improvement of the net profit to you rather than the improvement in the gross returns.
You probably remember when you received your first paycheck and were shocked when you realized that a big portion of your paycheck went to taxes. With your investment statements, you do not have it presented to you that way. You see your statements but your tax returns are done on a separate set of papers. Most people never make the connection to what they paid in tax on a particular investment, an account or a type of an account, such as an IRA.
With GAMMA, you can now focus on the net results of the real profit versus the gross profit. GAMMA focuses on four improvements that you can make to drastically change the outcome of your investments. In a recent study by the giant investment company WealthFront, they estimated that the total improvement by using both GAMMA -1 and GAMMA -2 is 4.6 percent per year.
■ GAMMA-1 focuses on reducing fees. This fee reduction strategy is accomplished by moving away from open-ended mutual funds and focusing on Exchange Traded Funds, individual issue stocks and bonds and in some cases closed-end funds. WealthFront estimates that by using fee reduction strategies you can improve your returns by up to 2.1 percent per year.
■ GAMMA-2 focuses on reducing taxation. Using the same study from WealthFront, you can obtain an improvement in net take home returns of up to 2.5 percent per year. This improvement is by using four add-on portfolio management techniques. These techniques are:
A) Tax swapping
B) Tax allocation
C) Tolerance rebalancing
D) And tax loss harvesting
What affect can this small amount have on your accounts? If you only improved your net after tax returns by 4.1 percent on $100,000 you would have an additional $49,454 in your account in 10 years. This is almost a 50 percent increase without taking any additional risk.
This begs the question, “Is your advisor or company doing this for you?” If you are a do-it-yourself investor, “Are you doing this for your own portfolio?”
If you have been working with a fiduciary advisor who does not work for a large company and customizes each portfolio, you probably have already been exposed to these techniques. In my personal experience, the larger financial companies know about these techniques but they are much too time intensive and expensive to deploy. Rather than have customizations for each client, they have to use the “large assembly line” concept to be profitable. You can tell if your financial company is using this “assembly line” strategy on your portfolios by asking these questions;
1. Do each of your accounts hold the same investments? If so, you have not been using GAMMA.
2. Has your advisor moved all equity investments to your non-retirement account and put bonds and REITS into your retirement account? If not, then you have not deployed GAMMA.
3. Do you see your advisor moving investments that have gone down between different accounts to get tax benefits? If not, your portfolio is not using GAMMA.
4. Do you see tax swaps by moving shares between your IRAs, ROTHs and non-retirement accounts? If not, then you might be missing out on net returns by missing GAMMA.
Based on our country’s debt, the high stock market and low interest rates, it makes sense to reduce risk but still find ways to improve returns. Look to use GAMMA as a portfolio overlay technique to increase your potential for better net after tax returns.
Kenneth Himmler Sr. is president and CEO of H&H Retirement Design and Management Inc. in Las Vegas. Reach him at firstname.lastname@example.org .