How can anyone put together an investment portfolio when the tax cost is unknown?
I have sat in on a lot of meetings with clients as various financial advisers, money managers, and institutional relationship officers present their latest investment allocation model.
What is clearly missing from the equation in the analysis of the projected portfolio's performance is the impact of potential tax scenarios.
As of now, what will be the tax law applicable on investment earnings, gains, and losses is at best uncertain and at worst devastating.
The Obama administration has presented its revenue proposals, which will have significant consequences as to final investment returns. Even more so are the changes in any investment portfolio design.
Congress isn’t giving any comfort. Both Democrats and Republicans are positioning themselves for the election so nothing being said currently is anywhere near reliable.
The Tea Party members of Congress are unable to convince either party's Congressional leadership of the need to reduce tax rate levels and cut spending. The actual amount of deficit is growing and the value of the dollar is diminishing.
What does it mean to an investor to have a Dow at 13,000 when the purchasing power of the dollar is diluting as fast as the Federal Reserve prints money out of thin air.
It's not above Congress to pass retroactive tax legislation. This means that current reliance on existing tax law might well be misplaced.
Clearly, the Obama administration and the Congressional leadership of both parties are planning on increasing borrowing, the Fed printing more fiat currency, and spending even billions more than any possible tax revenue can be collected.
It doesn't take a psychic to see that if there is no agreement in Congress and whoever the president is, the current tax rates will sunset and investors will be subject to the pre-Bush tax rates.
Have you considered that likelihood in your choice of investments?
What do you think will happen later this year when the financial world wakes up and starts to realize that dividends are likely to be taxed as ordinary income instead of at capital gains rates?
Will there be a rush to sell dividend paying stocks to get into something that will represent a store of value even if it doesn't generate current income?
As the market is more or less 70 percent or so program trading, what is going to happen when the algorithms kick in? Will the market go up or will a selloff in mass cause a major drop?
There is also a sleeper which nearly all investment people overlook when it comes to investment portfolio design.
Let's assume that the Obama administration's estate, gift, and generation skipping taxes are at the 2009 levels. That is, a $3.5 million estate tax exemption but only a $1 million gift exemption. Combine that with a modification of the valuation rules and limitations on the GRAT technique, and estate planning becomes a very expensive and even more difficult exercise.
The wide-spread belief is that the "market" takes into account events that may occur six months in the future. I don't think that's exactly true. I think the "market" has a short term view based on data, the herd mentality, and trading.
Analyzing tax law isn’t the main focus for such a fast moving crowd, generally.
What counts at the end of the day is how much money is left after paying the investment cost of tax.
What that tax cost will be is unknown. What is known is that it’s a major factor in creating a volatile investment environment.
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