Tax-aware investing should expand client choices, not constrain them

Advisors don’t lack tax planning opportunities. There are plenty of them. What I saw missing in tax-aware investing were two things: access to powerful, newer strategies that demand sophisticated implementation, and real coordination between tax strategy, investment management and the rest of a client’s financial life.

We knew the traditional tools for managing concentrated stock and embedded capital gains, but we were often reluctant to recommend them because the tradeoffs diminished, or even reversed, the benefits. Saving taxes isn’t automatically a good outcome if it means accepting lower returns, poor diversification, illiquidity or painful restrictions on how a client can use their money.

That led us to a different question. What if tax management were an ongoing part of portfolio management, rather than something addressed periodically after gains had already piled up?

Tax management as a process, not a product

The answer became Ultra Tax Efficient Wealth Management®, a process rather than a single strategy. Depending on the client, the toolkit might include familiar planning moves such as Roth conversions and charitable giving, or investment strategies such as direct indexing, exchange funds, or tax-aware long-short strategies. The point isn’t to use more tools. It’s to select and coordinate the right ones across a client’s entire portfolio and entire investing life.

Our objective isn’t the lowest tax bill possible. It’s to reduce unnecessary tax drag without sacrificing returns, diversification, liquidity, flexibility, or the client’s ability to actually enjoy their wealth. Good wealth management, including good tax strategy, should expand what a client can do with their money, not constrain it.

Tax-aware long/short (TALS) strategies illustrate the approach. When we first learned these strategies were available to individual investors, most advisors and investors we spoke with had never heard of them. Yet they offered a potential answer to a problem we had been trying to solve for years for clients with large, embedded gains and concentrated positions. TALS offers the potential to generate meaningful tax losses while maintaining diversified market exposure. When properly implemented, it also seeks to generate positive pre-tax returns, although neither outcome is guaranteed.

Our clients were never guinea pigs. Strategies this sophisticated must be implemented correctly, so experience matters. Our chief investment officer, Robert Hendershott, has spent decades designing and managing long-short strategies in institutional and hedge fund settings, so we could look under the hood, model the risks and tradeoffs, and judge how the strategy fit each client. Adoption has since accelerated, to the point thatmajor custodians have tightened access to tax-aware long-short accounts, but industry momentum never drove our decision. We found a tool that solved a real problem our clients already had. Like every strategy we use, it has to earn its place.

Explaining complexity without teaching the machinery

TALS uses leverage, active trading, and short sales, all things investors are taught to approach with caution. We learned an expensive lesson about how to talk about it. Our first technical articles and videos disproportionately attracted do-it-yourself investors who wanted to pick our brains, not hire us. Our best clients don’t want to become long-short experts. They hire us because they trust us to be experts.

So we rebuilt our library around stories and everyday metaphors. In one, leverage is like driving down a mountain: added long exposure is the gas pedal, and the short overlay is the brakes. In another, we’re making a pot of stew. Turning up the heat adds leveraged long exposure, and adding stock, water, or wine- the short overlay- keeps the pot from boiling over.

Our job is to make the decision understandable, not to teach clients to operate the machinery. They need to know what we’re trying to accomplish, why, the meaningful risks, costs and tradeoffs, and how it fits their broader financial life. Then they need to trust the professionals they’ve hired, the same partnership at the heart ofwhy serving women became our wealth management growth strategy.

When sophistication becomes overengineering

We’re naturally skeptical of complexity. Sophistication isn’t a benefit; the client’s outcome is. So, I always ask what a strategy allows the client to do that they couldn’t do before. Maybe it lets someone diversify a highly appreciated position without realizing every gain at once, creates losses to offset gains elsewhere, or preserves flexibility around a home purchase, retirement income or a liquidity event. Those are real outcomes.

But I would never evaluate a strategy by asking only how much tax it could save. I also want to know what the client has to give up saving it. If we cut someone’s tax bill but add excessive fees, unwanted risk, illiquidity, poor diversification, or restrictions on using their wealth, we may have won the tax battle and lost the financial planning war. That is whytaking a harder look at long-short strategies matters as much as the tax math.

Sometimes the most sophisticated recommendation is not to use the sophisticated strategy. Taxes are one variable in a much bigger equation. The goal is to avoid unnecessary taxes while preserving what ultimately matters: the client’s choices, their flexibility, and their ability to use their wealth to build the life they want.

Hilary Hendershott, MBA, CFP®, is the founder and CEO of Hendershott Wealth Management®.

^{UTEWM GENERAL Disclaimer
All investing involves risk, including the potential loss of principal, and there is no guarantee that any investment plan or strategy will be successful.
Advisory services are provided by Hendershott Wealth Management, LLC (“HWM”), an investment advisor registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training.
Content discussed is for information purposes only and does not constitute an offer, or solicitation of an offer, or any advice, or recommendation to purchase any securities or other financial instruments–and may not be construed as such.
All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation–and all examples are hypothetical, not reflective of actual executed transactions or client experiences.
The realized tax benefits associated with tax-aware strategies may be less than expected or may not materialize due to the economic performance of the strategy, an investor’s particular circumstances, prospective or retroactive change in applicable tax law, and/or a successful challenge by the IRS. In the case of an IRS challenge, penalties may apply.
There is a risk of substantial loss associated with trading commodities, futures, options, derivatives and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate.
When trading these instruments, one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading derivatives and using leverage. All funds committed to such a trading strategy should be purely risk capital.
Investment minimums apply. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation.}