In this week's show, we talk about some of the secrets to tax-efficient investing strategies specifically tailored for tech stock portfolios.
As someone working in the tech industry, you may have significant shares tied up in your employer's stock—with great potential for appreciation, but also significant risks. Listen as I break down the potential volatility and tax implications of concentrated stock holdings, and walk you through a real-world case study of a high-income client and discover the ways we evaluate the quality, valuation, and technical conditions of your current holdings, strategically plan for long-term growth, and diversify your portfolio to mitigate risk. Efficiently managing your investment returns is crucial, especially when balancing a diversified portfolio. In this episode, we delve into advanced tax management techniques like tax loss analysis and harvesting. I'll reveal how to prioritize long-term gains for favorable tax treatment and share the advantages of donating highly appreciated stocks to charity.
Discover the importance of selecting high-quality businesses with strong competitive advantages for long-term investment, and why working with a financial advisor can help you stay disciplined and aligned with your financial goals.
Don't miss out on this wealth of practical advice designed to make your investment journey smoother and more tax-efficient.
Highlights
In this week's show we discuss:
- Acknowledging the significant gains in tech stocks over the past five years and a caution about current overvaluation.
- Strategies for diversifying tech stock portfolios to find good opportunities.
- Discussion on the challenges associated with concentrated stock portfolios.
- Evaluation criteria including quality, value, and technical conditions to determine stock attractiveness for long-term holding.
- Ranking stocks based on percentage gain from cost basis to minimize tax impact.
- Emphasis on prioritizing long-term gains over short-term gains for favorable tax treatment.
- Maximizing after-tax rate of return, particularly for high-income individuals.
- Suggestion to donate highly appreciated stocks to charity to reduce taxable gains.
- Importance of working with a financial advisor for managing complex decisions and aligning them with personal financial goals.
- Encouragement for listeners to delve deeper into the conversation for detailed strategies on tech stock investments and tax efficiency.
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Transcript
(Generated for reference - May contain errors)
Hi, I'm Louis Llanes and this is the Market Call Show.
Today I'm going to be talking about something that I ran into, and I run into quite a bit lately, you may be in this position, but I'm going to be talking about smart tax moves for a stock portfolio, basically, tax tips for people who have tech stocks. A lot of people have been making money in tech stocks over the last five years or even more, and they're highly appreciated, and if you work for a tech company, you may have quite a bit of that tech stock because the company has been granting you shares and you've been getting more and more tax lots over time at various prices, and maybe you even started investing in other stocks and those stocks have gone up in value. Maybe you've been emphasizing tech stocks in general, which has been a very smart move, but a lot of people would argue that a lot of tech stocks are overpriced today compared to their fundamentals. Things that savvy investors are thinking about today is how do I get a good, solid portfolio when I have a concentration in tech stocks, in particular, maybe your company stock? So I'm going to kind of just use a case study of an actual client, an actual person that we have been working with in helping them solve this issue working with in helping them solve this issue and this particular person works for a large tech company and has been acquiring the stock over time and he wants to get a tax-efficient portfolio because he makes high income and he doesn't want to pay a lot in taxes. None of us really want to pay a lot of taxes. That makes total sense. So what we're looking at is how do we take these tech stocks that he owns and he owns a lot of different ones Apple, anet, micron and others how do we take those stocks and then diversify them in a way that makes sense into good opportunities? So what I want to do is just first talk about the challenges of concentrated stock portfolios and then work our way methodically into how would you go about thinking, solving this problem and what is the best way, in my opinion, to deal with it.
So, first of all, the risk of concentration is pretty self-explanatory. You have overexposure to a single sector or a single company and that could potentially lead to high volatility and risk in your portfolio because any one of those stocks could have a bad scenario. Something can come out of the blue that you don't expect and, as you know, tech stocks can be very volatile and you could have a very large loss. I was actually thinking about a client, another client who we advised to sell a stock I won't mention the name of the stock, but she had quite a bit of concentration and we repeatedly advised them to do this type of strategy, to get a portfolio that was sound to deal with the ups and downs of the markets and the economy. And because of the tax bill, she did not want to do it and instead of having a seven-figure portfolio, now they have a six-figure portfolio, a significantly less literally 10% of the value of what they would have had had they followed the advice. So this is very important information for a lot of people and if you are in this position, hopefully this can help you. So, talked a little bit about the risk of concentration.
Once you kind of just understand the situation, the first thing to do is to do an initial assessment, and that starts off with a portfolio evaluation. So you want to evaluate the quality, the valuation and the technical conditions of your current holdings. That's generally the process that I like to take. So, basically, when we're talking about quality, we're talking about how certain or how much confidence do we have in this business, in the business of each stock, each company, to generate cash flows over the long term and to have solid growth. Also, we want to look at in terms of quality how strong is the balance sheet? How much debt do they have? How much cash do they have? What types of return on capital are they getting? What types of profit margins are they getting? Do they have a long-term competitive advantage that can last for a long time? Because when you have a large position like that, you can't just make big moves all at once. You know you definitely want to think about the longer-term implications and longer-term expected returns.
So we also want to look at the current price, which is getting into the valuation. So what is the price per share now? What is its market capitalization and how is that compared to fundamental metrics of value? So it's always good to have an idea about, you know, based on sound economic principles, what is the valuation or reasonable valuation range for the company. So that would be really based upon the after-tax net cash flows to equity shareholders as well as the business risks that are involved and you want to discount that back to get some form of valuation. Or you want to look at the you know the multiples that you're paying for, kind of the earnings power of the company on average. You don't want to take any one point in time, but like on average, you know, given a reasonable growth rate, that you would expect for the company, given its average earnings. Based on that, what is the multiple? And if those are really out of whack, then that tells you that, meaning that it's very overpriced compared to its fundamental valuation. That is another reason to want to sell.
So, basically, when you're looking at these conditions, these three conditions quality, value and technical the purpose of doing that is to get an attractiveness kind of score. So how much do I really want to hold this longer term? So let me just back up and talk a little bit about the technicals. The technicals is an analysis of the supply and demand for the shares right now. Because you want to understand is the stock under pressure right now or are people still very optimistic in the stock and still bidding it up? Because, depending on what type of conditions you're in there, that would influence your strategy for how you would exit. Okay.
So after the first evaluation, you want to you know you've looked at the quality and the value and the technicals. Then you want to look at the highly appreciated stocks and then you also want to you know you've looked at the quality and the value and the technicals. Then you want to look at the highly appreciated stocks and then you also want to look at the stocks that you may have in your portfolio with a loss. So, basically, what you want to do is you want to rank based on the percentage gain from your cost basis, what you know. How highly appreciated are they? How highly appreciated are they? And the reason why this is important is because for every dollar that you raise in cash to reinvest somewhere else, you'll have more gain. If it's highly appreciated, the higher the appreciation is. So what your goal is is to minimize the tax impact and get as close as you can to your target allocation. Okay, so when you're doing this, it's really a good idea to have a tax budget for the year. So you're saying, okay, based on my tax situation, my income levels, where the tax brackets are now, this is how much capital gain is reasonable that I'm willing to have in this year so that I can manage my taxes, all right.
So we've done the portfolio analysis, evaluating the quality, value and technical conditions of the holdings. Then we want to look at kind of the diversification strategy and what your target portfolio construction looks like. So that's really looking at. You know, if you're heavy in tech, for example I'm just using tech as an example you could be heavy in financials or industrials, anything like that. You want to look at what are the attractive stocks in other sectors and in other businesses that are not correlated to what I have a big exposure to, and what is my target allocation that I want to shoot for. So you create a diversified portfolio that you're shooting for and the whole objective there is to balance return and risk. So you're focusing in on high-quality companies with strong fundamentals and the companies that you want to buy as well, because in this type of a portfolio you're dealing with a taxable portfolio. It's a good idea to be focused on not short-term trading, because that generates higher taxation, more costs. It's generally best overall to be focused on long-term capital appreciation where your after-tax rate of return is the strongest. So you want to have companies that are high quality and have those strong fundamentals that you can hold for a long period of time and buy them at attractive prices or reasonable prices. So your aim there is to get the sector diversification beyond the industry that you have a concentration in. For example, if you're heavy in tech, you want to go more into health care, more into financials, more into materials industrials. That's pretty self-explanatory. Or it could be within tech, but with less correlation. Okay, so you may just broaden out your tech exposure as well as going into other sectors. All right, so that's kind of your diversification strategy.
Then you want to go into tax management techniques to actually get to where you want to go. And that starts off with that tax lot analysis that I had mentioned, where you identify which stocks that you want to sell first to minimize the tax impact, which stocks that you want to sell first to minimize the tax impact. And as you're doing this, you want to sell any of your losing positions first, any positions that you have that are at a loss, that are also not attractive, that you want to own. That would be tax loss harvesting. You want to go ahead and harvest those losses and then you kind of know what you're working with with your losses. And then the next step is you want to work towards prioritizing long-term gains versus short-term gains, so that gives you more favorable tax treatment. As I mentioned, long-term capital gains may be at a lower rate for you especially if you're high income than short-term capital gains. So you want to prioritize those long-term capital gains. That doesn't mean you shouldn't have short-term capital gains and I'll get into that a little bit here in a second but you want to prioritize the long-term capital gains.
Okay, now you want to get to kind of your implementation steps and you want to start by first reducing those concentrations and you want to sell the least appreciated long-term capital gains first. So you're starting off with the least attractive stocks, right, that have the highest appreciation, and you have a long-term or the lowest appreciation, I should say, and you have a long-term gain. That's what you want to sell first. And then you want to gradually sell higher appreciated stock lots, while considering the tax implications of that, and then you want to reinvest those proceeds into your target allocation sector. So you may be in a position where you're going to be selling some short-term, some stocks at a short-term gain, and the reason why is because a lot of times the most recent stock you got are the least appreciated and you still need to reduce your concentration in a particular stock. So some of those gains may be short-term and that would be optimal for you so that you can get that concentration down, all right.
So another thing to consider is if you're in a position where you want to give charity and you want to donate stock, it's a good idea to use stock that's highly appreciated. So if you're going to make any donations in a given year, look at those stocks that have the highest appreciation and that are least attractive. You know in that order really. And if you have a concentration so it's kind of again a balancing act so don't donate that stock first and that'll reduce your taxable gains there, all right. So you want to select the least attractive stocks from a fundamental perspective for your donation, if you can, because because you know you want to hold on to your winners and you want to let go of your losers, right. But if you are trying to avoid taxes, sometimes your winners are extended and it's time to. When I say least attractive, I mean least attractive of the current price relative to the economic fundamental value.
So it's so interesting talking about this topic because it can be confusing for some people because it almost sounds like you're talking out of each side of your mouth and you are in one way, because you're balancing. You're balancing expected future after-tax rates of return with how much pain I'm going to have to take in taxes right now, and, like I had mentioned with that client who you know, lost a ton of money that could have been avoided, and the sole reason why she lost a lot more than her tax bill would have been let's put it that way Okay, so my purpose in doing this is to help people and I hope to help people actually benefit from this if you're in this situation, because right now the markets have had a big run-up and a lot of people are holding a lot of tech stocks right now. So, again, we're talking about a balancing act between your taxes and your returns. So you want to optimize that after tax rate of return and you focus on maximizing that after the return potential that you have over the long term, not just the current gains. So what you want to do is you want to actually give yourself a budget and that's helpful so that you can give yourself an uncle points like I don't want to have more than this amount of taxes, all right, so you want to align your portfolio with your long-term investment goals as well. So you know, if you're going to be retiring soon, you might be needing to make some of these adjustments ahead of time. If you're an executive working for a company, you might want to start this process sooner rather than later. The other point I wanted to reemphasize is that you want to consider high quality businesses with a strong competitive advantage because, again, you want a long-term approach with this.
In general, it's not a good idea to do short-term trading in these types of accounts because of the tax impact and the costs involved. All right, so I just want to kind of bring this like my final thoughts here together on this, and hopefully this can summarize for you some key takeaways. It's important to have a disciplined approach to tax management and diversification when you're in this position, and you know it's a good idea. If you don't have like the software or you know the understanding about the valuations or the time to deal with all of these types of decisions, it's a good idea to work with a financial advisor or an investment manager that is very, very experienced in this and understands the nuances between after-tax rate of return, as well as your particular situation and how to get you to where you want to go. They can help you with the decisions, and I encourage you to review and adjust your portfolios regularly to make sure that you're aligned with your financial goals. So just to summarize those main points maximize your after-tax rate of return.
Don't let big concentrations derail your retirement plans or other plans that you have. Be sure to use a disciplined approach based on strong fundamentals for the long term and not based on short-term considerations. Don't overemphasize taxes. Look at the overall result that's coming to your benefit over the long run and look past the current year. Well, that's it for now.
I really want to encourage you to listen to my podcast. I'm going to be having a lot of new guests coming on and we're really going to be focusing in on investments and what's happening now. I'll be introducing a market metrics really kind of summary of what's happening right now prior to getting into our topics, so that will also help you. You know, just get of summary of what's happening right now prior to getting into our topics, so that will also help you. You know, just get some perspective of what's coming across my desk talking to various professionals in the business that could be helpful to your wealth, and I encourage you to subscribe to the podcast, if you have not done already and if you like this type of information, you know, feel free to share it with your friends, colleagues, professional people you know, and I invite any of your questions.
So if you want to, you know, get more information, you can go to path to real wealthcom and you can learn more information there about me. They'll also be. You can subscribe, you can get to the podcast there and there's also going to be more information that we're posting there that should be of value for you. That will allow you to get various publications that I might put out, and you could also, if you want, to read my book, the Financial Freedom Blueprint. It's available there. You can also get it on Amazon or anywhere else. That's all for now. Thank you for joining me and we'll talk to you soon. Have a great day.