CONCLUSIONS

Equities are an important part of most investors' portfolios. Optimally exercising the taxpayer's control over the recognition of realized gains and losses could meaningfully increase after-tax return.

There is tension between the desire to enhance return through active management and the desire to enhance return through capital gains tax deferral. The core and satellite approach allows investors to better manage this tension.

The core and satellite approach breaks equity holdings into two components with very different tax characteristics. This allows for more effective asset location strategies.

OVERALL CONCLUSIONS

We can review the progress we have made during the past four chapters by looking at the increase in expected wealth transfer for each family. We created an efficient frontier that integrates estate planning and investment decisions. We demonstrated that optimal integration can produce significant improvement in the efficient frontier. The investor can expect to transfer more wealth for a given level of risk, or could expect to transfer the same amount of wealth with less risk. Using the 8 percent volatility solution as a reference point, from no estate planning through to full use of asset location, equity portfolio structure and tax loss harvesting generated a 44 percent increase in the expected future real wealth of the Jones children. The same process increased the expected future real value of the Smith foundation by 17 percent. The Joneses derived a greater increase because they were faced with the 50 percent estate tax. Table 32.8 demonstrates this progress. What is important to keep in mind is that the progress was achieved without increasing risk. Integration of investment and tax planning created the additional return.

We have demonstrated a process for applying modern portfolio theory to the special requirements of taxable investors. The four key steps are:

1.    Frame the problem according to the investor's long-term objectives. This sounds simple but is often overlooked. The proper framework can bring much clarity to investment planning.

2.    Investors have choices regarding asset allocation, asset location, and equity management strategies. These choices affect income and transfer tax liabilities. Understand how these options relate to the investor's long-term objectives. Optimally exercising these options can meaningfully enhance results.

3.    The efficient frontier will differ for each investor. An investor's efficient frontier should represent a series of asset allocation and location mixes that provide the highest possible expected after-tax result for a given level of risk. The efficient frontier is based upon optimal exercise of the various tax options. Build a mathematical model that relates expected return, risk, a correlation matrix,