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Why Intelligent Tax Optimization is the Next Shift in Advisor Trading

By: Dane Kurtz
Senior Product Manager – Trading, Nitrogen

As the independent advisor model has taken hold through wealth management, a parallel movement has risen up in technology built to support those advisors.

From dedicated CRM platforms created just for advisors, to portfolio management, to risk and portfolio analytics like what we’ve created at Nitrogen, advisor technology has taken off and drastically changed and improved the day-to-day operations of advisors across the country.

But there’s one all-important area of an advisory firm that hasn’t seen similar leaps and bounds as others. I’m talking about the way in which advisors trade.

There have been a whole host of advisor trading applications created, of course, but by and large many advisors still rely on spreadsheets or even good old pen and paper to rebalance accounts and figure out what to buy and sell.

Let’s be honest: It’s not efficient, and it can end up hurting an advisor’s clients’ returns as much as it hurts an advisor’s own productivity.

For advisors to be their best, this needs to change. Last year, we announced our vision for where we see the future of advisor trading going.

I’ll let you in on that vision in this article. But first, we need to understand where advisor trading has been, and where it is now, before we can appreciate where it’s going.

Let’s dive in.

How Advisors Trade—Then and Now

When you think about how advisors trade, and especially the trading software built for them, you can approach it in two ways.

  1. How scalable does the trading approach make a firm? Does it give them additional time to do other things?
  2. How easy is the trading workflow to learn and use? Can an advisor intuitively exercise discretion and control over a portfolio, or is it simply a manual process dressed up with a fancy design?

About 70% of advisors today still take the manual approach, where they enter one trade at a time (or even in a batch using a spreadsheet) into their custodial platform.

This isn’t all that different from how most advisors were trading back in 2005.

While it’s not a scalable process, it is rather simple. It gives advisors clarity into what’s happening in each account—but that’s because they’re being traded one at a time.

So what about the other 30% of advisors who use rebalancing software? It definitely provides some scalability—but let’s face it, these products are like the VCRs of wealthtech.

They have a rigid, models-based approach to trading and try to force a one-size fits all. And even worse—they don’t provide any ease of use benefits. They’re so complex, it’s hard to click into any one account to see what’s going on immediately, and even though they claim to automate the process, they’re still crazy manual.

Here’s one example.

One rebalancing tool claims to offer tax-sensitive rebalancing. In practice, that means it gives the user a rules-based approach to sell loss positions first, then long-term gains, then short-term gains.

It’s better than nothing, but it’s not “smart.”

When it comes time to rebalance, you have to sync or export data from one part of their system to another. Then you run model rebalance analytics. Then you actually run the rebalance. Then you create orders. Then  you approve them. Then you process the orders. Then you approved the block orders. Then you execute them. Then you highlight the allocations. And then, by the grace of God, you finally execute the allocations.

Ten arduous steps later, you’re done. And this is considered “state of the art.”

With “innovation” like that, it’s no wonder so many advisors choose to continue rebalancing in Microsoft Excel.

We could also write an entire blog post about how “automated” tax loss harvesting requires the same amount of review and number of steps for advisors.

Suffice to say, “automated tax loss harvesting” in rebalancing products today amounts to little more than the advisor getting an alert that there’s an opportunity, and then having to go through another ten steps of settings and confirmations to actually execute on that information.

Any scalability promised by these rebalancing products is quickly eaten up by how ridiculously hard to use they are.

It’s clear that a rebalancing product has to offer advisors more scalability, but it also has to save them time while offering powerful features.

And as valuable as those benefits are, rebalancing software is even bigger than that.

It’s not just about saving time; it’s about changing the very value an advisor can deliver to clients.

How Advisor Value Has Changed Through the Years

The primary value offered by an advisor has changed through the years.

You can see it simply in this image:

Time Period Primary Value
1980s and 1990s Investment Alpha. But we all know chasing returns isn’t a sustainable value proposition.
2000s Planning Alpha. There’s still a lot of value in planning, but an ever-present difficulty in getting clients engaged and committed.
2010s Risk Alpha. This happens when great advisors construct the right risk-adjusted portfolios and help clients make (and stick to) the right decisions along the way.
Today and the Future Tax Alpha. When advisors have the ability to save clients real money on taxes — primarily by getting the portfolio to the most optimal place possible while avoiding capital gains — the compounding value of that extra money in the client’s account can blow everything else away.

In the next section, I’m going to tell you how Nitrogen is advancing rebalancing technology to help you deliver tax alpha by focusing your expertise on the decisions that will make you your clients’ tax superhero.

The New Value Advancement: Intelligent Tax Optimization

If you haven’t already started using Intelligent Tax Optimization in Nitrogen Trading, I’d love to show you how it creates tremendous value for your clients and saves you time.

Let’s say you’ve got a new client who transfers in a taxable account that is currently a Risk 85, and your goal is to get that account to a Risk 55.

The problem is, the client has a pretty low cost basis in a lot of the concentrated stock exposure that is driving all of that extra risk, and getting them to a Risk 55 will generate $100,000 in capital gains.

Intelligent Tax Optimization lets you set a budget for how much in capital gains your client can handle, and then the technology will go to work, generating millions of scenarios for the precise number of shares to sell from the most optimal combination of tax lots to get you as close to the Risk 55 as possible while staying under your capital gains budget.

Here’s a scenario to help you picture how easy Intelligent Tax Optimization makes it.

  • The Scenario
    Amanda Smith has a large legacy Apple position with multiple tax lots. She wants to sell a little over half of it to buy a more diversified portfolio of ETFs.
  • The Position Details
    She bought Apple at four different times, and all have unrealized gains. Three are long term and one is short term.
  • The Problem
    We need to sell 800 shares. But which tax lots do we sell?If we used a rules-based rebalancer, it would follow the rules—even if those rules don’t allow for the most optimal result.
  • The Solution: Intelligent Optimization with Nitrogen
    All you need to do is select “Avoid short-term capital gains” for Amanda’s portfolio.And instead of just following rules, we’re going to incorporate this client’s tax bracket data to run literally millions of scenarios in seconds and generate precisely the most optimal output.The recommendations are all computed and done for you. Intelligent Tax Optimization determines that it’s best to sell all shares in tax lot three and some in tax lot two. The long-term gains incurred would tack on about $44,500 onto Amanda’s tax bill—but because we know her tax bracket, Intelligent Tax Optimization finds a slightly different combination of shares to sell, in the same quantity, to reduce her capital gains by another $6,000.All of these calculations can dynamically change based on the capital gains budget you set for Amanda. If you increase her capital gains budget to $150,000, you’ll get a completely different recommendation.

The best part is, there aren’t ten steps to review and approve to get this all done. We serve up these scenarios just like an email inbox—so you can accept or snooze the recommendation.

It takes being a one-click fiduciary to an entirely new level.

Nitrogen can optimize accounts with hundreds or even thousands of tax lots at varying gains and losses, and serve up an optimized path to success that turns you into your client’s tax superhero.

There’s so much more to cover about how Intelligent Tax Optimization can make it simple to be tax-conscious while also giving you time back in your day to connect with clients or work on your business.

More on tax alpha: See how we’re putting true automation into automated tax lot harvesting.

See it in action: Catch up by watching Nitrogen’s full product keynote

Dive into the details: Embrace the math behind Intelligent Tax Optimization by downloading our new white paper about why optimization-based rebalancing is superior to rules-based rebalancing.

Talk to a specialist: We’d love to show you around!

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