NEWS AND INSIGHTS | INSIGHTS

Custom Direct Investing: Working All Levers

January 31, 2024
SHANNON SACCOCIA, CFA, CHIEF INVESTMENT OFFICER—PRIVATE WEALTH
GARRICK HULL, ASSOCIATE PORTFOLIO MANAGER

Tax-managed portfolios can serve as a foundation in solving multiple investment and financial challenges.

Taxes are a constant shadow in investing that is often interwoven with key decisions around portfolios. Should I sell a concentrated stock position despite the large capital gains that I’d realize? How can I shape my investments to be more in line with my goals without incurring excessive tax costs? How can I efficiently secure access to diversified portfolio exposures? How can align my assets closer to my social values? These questions and more have long challenged investors, but we believe they have found increasingly effective answers in custom direct investing, or CDI.

Addressing Multiple Issues

Our approach to custom direct investing is an outgrowth of a couple investment trends. One is traditional indexing, or matching a particular market benchmark in a mutual fund or ETF. Another is direct indexing, which involves building an index-like portfolio on a separate-account basis. CDI takes things further by introducing additional layers of customization to establish portfolios that cater to specific preferences, including accommodating existing holdings on a tax-efficient basis while drawing on the benefits of active investment strategies.

Executed properly, we see CDI as a way to address a variety of issues faced by investors:

In a high tax bracket with material tax liabilities. CDI can defer capital gains and harvest capital losses, when available, which can be used to offset gains elsewhere in your portfolio and reduce your overall tax bill. This can be exceptionally powerful as it allows you to remain invested in the market and to potentially compound tax savings over time.

Align investments with personal values. On a tax-efficient basis, it’s possible to implement screens catering to personal values, for example by excluding tobacco or firearms, or restricting certain industries or stocks. You can also invest in portfolios that take into account environmental, social and governance (ESG) factors in their processes, or seek to create specific impacts tied to ESG issues.

Reset appreciated stock portfolios. Investments that were once appropriate for you may no longer serve your needs; some may have grown disproportionately, leaving your portfolio out of balance. The CDI framework offers flexibility by systematically harvesting losses in specific securities (a common occurrence even in a good year for the markets). This permits the sale or trimming of existing holdings to bring portfolios more into balance. The approach can also help to maximize the impact of charitable giving or allow you to raise cash more efficiently when you need it.

Deal with concentrated stock positions. Many executives and their families puzzle over how to reduce the risk of a concentrated stock position, which has often grown as a result of compensation. Traditionally, the key question associated with a sale was how to balance the tax cost with the potential for appreciation or risk reduction in other investments. CDI can make things easier by enabling the construction of a diversified portfolio around that central position, while freeing up losses elsewhere from typical market ups and downs to tax-efficiently reduce the concentrated exposure.

Control your investment and tax experience. Much of the time, investing can seem to be about settling for ill-fitting investments because of restraints tied to taxes, or having to pay more taxes than you would prefer because of investment structure or in order to achieve liquidity for financial goals. Via personalization and tax management, CDI can help maximize your level of control over your assets.

Working With Us

We believe that the Neuberger Berman CDI platform sets the standard for tax-efficient separate accounts due to its customization, quantitative rigor and access to premier active investment managers. Investors who come to us with an existing portfolio and anticipate the need to sell their holdings and start over may be pleasantly surprised by their ability to integrate those securities into multiple diversified strategies. Moreover, our systematic approach to loss harvesting over time can make any sales less painful by offsetting realized gains, and thus can encourage appropriate diversification that might not otherwise be available. In our view, CDI is an innovative, efficient capability with great potential to address an array of situations and enhance the potential for positive tax-efficient outcomes over the long term.

Elements of Tax-Efficiency

In investing, it’s what you keep that matters—and central to that idea is tax efficiency. Key issues to consider include:

  • Holding period and turnover. Owning stocks for longer allows you to capitalize on potential secular growth while limiting portfolio turnover that generates realized capital gains.
  • Location. From an asset-location perspective, higher-turnover portfolios or tax-inefficient strategies like real estate investment trusts may be better placed in a retirement account.
  • Tax-advantaged assets. Certain investments have tax benefits—most notably municipal bonds, whose interest may be exempt from federal and state taxes.
  • Tax-loss harvesting. Tax-loss selling to offset realized gains traditionally happens at the end of the year, but CDI enables such harvesting on an ongoing basis across your portfolio, to ensure capture of losses for current or future needs.

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