The annual tax drag on a portfolio invested in the S&P 500 index is just over 1%. But that small number masks a compounding problem.
An analysis of returns on that same fund from 1976 to 2025 showed an overall tax loss of 45.4%, according to Gregg S. Fisher, founder and portfolio manager at Quent Capital. That makes the change of 11.67% to 10.57% after taxes look a lot different and puts even more emphasis on the need for advisors to factor in the tax consequences of a client's investments.
Tax management should be treated as "an active discipline rather than a once-a-year afterthought — a portfolio manager who doesn't focus on the tax effects of every decision is, in effect, passive with respect to tax management," Fisher wrote in a blog post.
Financial Planning has written extensively on methods advisors can use to dampen the tax hits their clients take. Read on below for five tax-aware investment strategies.
Section 351 conversions
A Section 351 conversion or exchange moves a stock portfolio to a newly launched ETF. It is meant to help investors diversify concentrated stock positions and defer capital gains taxes.
Still, the original portfolio can't be too concentrated. No security can exceed 25%, and the five biggest holdings can't be more than 50% of the portfolio.
Tax-aware long-short strategies
Another way to diversify concentrated stock positions and defer capital gains taxes is using long-short portfolios and tax-loss harvesting. In a 130/30 strategy, an investor shorts about 30% of portfolio assets and buys 30% more on margin, so the investor's long exposure is about 130%. Another proportion used is 250/150, involving more leverage.
Variable prepaid forwards
Variable prepaid forwards allow investors to pledge concentrated stock to get a loan. Investors are obligated to transfer cash or shares upon maturity. It's a way to get liquidity and hedge against concentration risk.
Options collars with margin loans
For an investor to use an options collar with a margin loan, the investor has to be a qualified purchaser using a complex transaction worth at least $1 million. It pairs a long put option at a lower value with a short call option at a higher value.
Direct indexing may or may not be a good fit
While direct indexing with tax-loss harvesting can be a useful strategy, Gregory V. Kanarian, an investment strategist at Natixis Investment Managers Solutions, wrote that tax-loss harvesting doesn't benefit qualified retirement accounts and might not benefit clients who are directing most savings into qualified accounts. In addition, fees that are too high can cancel out the benefits.
