The Theory

Ordinary income tax and short term capital gains rates approach 40% at the Federal level, and up to 11% at the State level. And with few exceptions, taxes are on the rise. Successful investing in the future will result in increased taxes. The impact could be significant. Historically, reducing the impact of taxes on your investment portfolio has meant looking for losses that can be realized near the end of each calendar year for most investors. In fact so much more can be done.

A significant body of research exists as to the impact of taxes on investor’s returns, and the benefit that an actively managed portfolio designed to minimize the impact of taxes can have on returns over time. Historically, less than 10% of actively managed funds were able to beat the S&P 500 on an after-tax basis. Even indexing, traditionally viewed as a tax-efficient alternative, has shown to suffer under the burden of taxes due to constituent changes, corporate reorganizations, and dividends. Mutual funds carry a further burden. By law, mutual funds are required to distribute 98% of their realized gains each year, but are not allowed to distribute any realized capital losses. By contrast, a number of studies have shown that actively managed tax efficient portfolios that incorporate an active tax loss harvesting strategy are able to have a significant impact on the portfolio over time.

The CIP Strategy

Since 1998, the Principals at CIP has managed an active tax management strategy which focuses on capturing market returns with minimal tracking error, while deferring the realization of capital gains and harvesting net tax losses to the extent possible. The Strategy is built on the simple notion that tax losses have economic value. Two portfolios of equal value, which realize the same rate of return, will have the same pre-tax value at the end of the year. If the first portfolio has realized taxable gains, while the other portfolio has been able to avoid realizing gains, the payment of taxes will cause the values to diverge. In addition, if net losses for tax purposes are realized, those losses can be used to offset capital gains realized in other portfolios the investor may have. The value of the tax losses is the ability to immediately offset gains realized elsewhere, resulting in immediate savings in taxes. This savings increases the investor’s net worth by increasing the after-tax return of their entire asset allocation.

CIP utilizes a sophisticated optimization program to invest the portfolios within our Active Tax Management Program. Each portfolio is managed individually by targeting the portfolio against a designated benchmark index, and regularly re-optimized to defer capital gains, seek out tax losses, and minimize tracking error to the benchmark. CIP manages portfolios that target both domestic indexes such as the S&P 500, and international indexes such as the MSCI EAFE index.

With over 10 years of experience maximizing after-tax value, we have found the Active Tax Management Strategy an essential tool to any taxable investor seeking to maximize the growth in their net worth.