Embedded Capital Gains

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Aug 14, 2007 8:51 pm

I had invested client's money into some mutual funds just before the market lost 1000 points.  I know I am not alone in this...it's just the nature of the beast.  Thing is, obviously many funds are down 3-8% and will need a big bounce by the end of the year to get some gains. 


So, many investors are going to have tax bills for the embedded gains even though they are down...nothing new.


Is anyone prospecting on this now or prospected on it in the past?  Have you found it to be successful?  I see it as a great opportunity to be a wedge.  How have some of you presented this to prospects?

Aug 14, 2007 10:40 pm

This is the time to make certain your clients know about all the services you provide - talk to them about estate planning, college funding, life insurance....

Aug 14, 2007 11:27 pm

In order for it to be a wedge, you have to demonstrate to a prospect that you can help them avoid embedded capital gains in a mutual fund while picking tops and bottoms.  Can you?  The only person I know who can do that is DAtoo.


I'd focus on using a wedge that points out the incumbent's lack of contact during a difficult time.  In the future, I'd set the expectation with a new client that the market and their investment will go down in the short term.  Murphy's Law, I suppose.  I would then remind them of the long-term nature of their investment and what the investment is intended to do for them.  If they are seeing 10% losses in that short of a time, they probably were too aggressively invested to begin with.

Aug 14, 2007 11:28 pm

damn, no edit function


If they are seeing a 10% loss in a short time frame and they've expressed concern, they may have been too aggressive given their time frame.

Aug 15, 2007 6:27 pm

have them take a realized loss, then transfer the proceeds into a variable annuity. this will avoid embedded tax gains in the future.and you get compensated for giving advice.

Aug 15, 2007 7:15 pm
deekay:

damn, no edit function


If they are seeing a 10% loss in a short time frame and they've expressed concern, they may have been too aggressive given their time frame.




Just had a client dump an advisory portfolio that they have been in since May 25th.  Thats the last time I fail to address expectations very clearly up front...

Aug 15, 2007 7:24 pm
drewski803:

Just had a client dump an advisory portfolio that they have been in since May 25th.  Thats the last time I fail to address expectations very clearly up front...



A shoe drops.  Any of the other boys and girls willing to admit that something is happening?

Aug 15, 2007 7:45 pm

I failed her as an advisor.  That doesn't have anything to do with market-timing or investment selection, DAtoo. 


If you must know, her total portfolio was down about 2.5% amidst a 5% correction in the S&P.  She was a new investor and I failed her as an educator.

Aug 15, 2007 7:51 pm
drewski803:

I failed her as an advisor.  That doesn't have anything to do with market-timing or investment selection, DAtoo. 


If you must know, her total portfolio was down about 2.5% amidst a 5% correction in the S&P.  She was a new investor and I failed her as an educator.



As I wrote elsewhere, all they have to do is say you didn't explain the risks.


Unless you are exceptionally bright their attorney will have you spinning like a top in discovery--and then even more in the actual hearing.


Your firm will probably decide that it's cheaper to just give them their money back and collect it from you via salary reduction.


You won't have a say in how it's handled.

Aug 15, 2007 7:57 pm
drewski803:
deekay:

damn, no edit function


If they are seeing a 10% loss in a short time frame and they've expressed concern, they may have been too aggressive given their time frame.




Just had a client dump an advisory portfolio that they have been in since May 25th.  Thats the last time I fail to address expectations very clearly up front...



I hope you turned off the fees and charged commissions on the way out the door.

Aug 15, 2007 8:00 pm

Isn't gone.  I'm probably going to boot them eventually though.  Not because they are bad people but because I will probably never regain their trust.

Aug 16, 2007 8:15 am
snaggletooth:

Is anyone prospecting on this now or prospected
on it in the past?  Have you found it to be successful?  I
see it as a great opportunity to be a wedge.  How have some of you
presented this to prospects?





Did you know that compared to mutual funds, ETF's almost never have embedded capital gains?



Betcha' your broker never told you that.

Aug 16, 2007 3:31 pm
AllREIT:
snaggletooth:

Is anyone prospecting on this now or prospected on it in the past?  Have you found it to be successful?  I see it as a great opportunity to be a wedge.  How have some of you presented this to prospects?




Did you know that compared to mutual funds, ETF's almost never have embedded capital gains?

Betcha' your broker never told you that.


Did you know that compared to ETF's, UIT's use a formula to try to invest in the top companies within an ETF, therefore we can try to stay away from the worst perfoming stocks within an ETF?


Betcha' your broker never told you that.

Aug 16, 2007 5:04 pm

Did you know that with a mutual fund there is a manager that gets to invest in the best companies within an ETF, and then trade them for another one if there is better idea?  You can get them inside an annuity and avoid those pesky cap gain conversations.  Or you can buy a tax managed fund designed to not produce cap gains.


If you've got a fund that's down right now, why not exchange it to another fund within the family at NAV.  Hold that new fund for 30 days and exchange it back.  Capture the loss to offset some of the cap gains that will inevitably show up at the end of the year.  Even better if you sold A shares because the commission becomes a part of the loss. 


Like lemons out of lemonade.  


Aug 16, 2007 8:36 pm
Spaceman Spiff:

Did you know that with a mutual fund there is
a manager that gets to invest in the best companies within an ETF, and
then trade them for another one if there is better idea?  You
can get them inside an annuity and avoid those pesky cap gain
conversations.  Or you can buy a tax managed
fund designed to not produce cap gains.


If you've got a fund that's down right now, why not exchange it to
another fund within the family at NAV.  Hold that new fund for 30
days and exchange it back.  Capture the loss to offset some of the
cap gains that will inevitably show up at the end of the
year.  Even better if you sold A shares because the commission
becomes a part of the loss. 


Like lemons out of lemonade.  





Not really spiff. More like "Lemonade" out of citric acid, a little
Nutrasweet and some flavoring from "Ben Wah Shanghai Dirtstar Biologic
Flavorings Co Ltd."



1. No proof the active managers add value, and thanks to other peoples
investments its possible to pay tax on other peoples gains. That
is intrinsic to the mutual fund structure. There is no way to avoid it.
All mutual funds (even passive index funds) have this problem.



Only ETF's with in kind redemption can avoid this problem.



2. It is the trading of the active managers that generates a goodly portion of the capital gains. This causes an internal tax drag.



3. Annuities suck, The cost of the VA whomps any reasonable amount of
internal tax drag and the full tax treatment upon withdrawl is an added
insult.



4. Is rolling around inside of an active fund family a good idea, when
each fund is designed to have a different investment mandate? It's one
thing to go from VDE to XLE, but something else to roll to a different
asset class.




Aug 17, 2007 11:00 am

I believe that "proof that active managers add value" is called Alpha.  And you can find that proof all over the place.  Anytime a fund has a positive Alpha, they've added value over your ETF. 


I'll agree that there are some tradeoffs with VAs, but you've got the same mentality as someone like Suze Orman.  How many guarantees can your ETF portfolio give my soon to be retired clients?  They're not for everyone, but just like everything else they can be great for some.


As to the rolling around inside the fund family, it depends on client goals now doesn't it.  Let's say I earlier in the year I bought New World.  Now, it's up say 50%.  Time to capture some gains and move to Fundamental Investors.  Lower risk, different objectives.  The rolling around I was talking about was a tax strategy, not asset allocation. 


Aug 17, 2007 2:51 pm
Spaceman Spiff:

I believe that "proof that active managers add value" is called Alpha.  And you can find that proof all over the place.  Anytime a fund has a positive Alpha, they've added value over your ETF. 


What if they got lucky? What if in reality, they are horrible managers, but got really lucky in the past.


Lets say you had 10,000 managers with an mean return of -5% per year, but a Standard deviation of +/- 20%. It wouldn't be hard to make up a list of 100 star managers.


I'll agree that there are some tradeoffs with VAs, but you've got the same mentality as someone like Suze Orman.  How many guarantees can your ETF portfolio give my soon to be retired clients?  They're not for everyone, but just like everything else they can be great for some.


I have the mentality of someone who invests in insurance companies, because of the huge profits earned from VA's.


I like owning tobacco companies, but I don't smoke.


Aug 17, 2007 3:09 pm
snaggletooth:

I had invested client's money into some mutual funds just before the market lost 1000 points.  I know I am not alone in this...it's just the nature of the beast.  Thing is, obviously many funds are down 3-8% and will need a big bounce by the end of the year to get some gains. 


So, many investors are going to have tax bills for the embedded gains even though they are down...nothing new.


Is anyone prospecting on this now or prospected on it in the past?  Have you found it to be successful?  I see it as a great opportunity to be a wedge.  How have some of you presented this to prospects?



Performance prospecting is a losing game.  I made some great moves and got out of the market at it's high, and bought back low.  Just lucky.  Can't expect that to happen all the time.


But my work ethic, the strength of my company and their research, my follow up, my expertise, that is what I prospect on.  Noone will work harder or care more.  That i can control, not the market.