The Taxable Investor’s Manifesto: Insights into a Quiet Revolution

Date: Oct 28 2020

Stephanie Simmons, Relationship Manager

Taxable investors need to think differently. Here Stuart Lucas, Co-Managing Partner and Chief Investment Officer at Wealth Strategist Partners, tells us why, and also how to extract value at the intersection of investing, estate planning and tax.

So what makes a good investment? Lucas gives us four elements:

  • An asymmetric risk profile
  • High potential magnitude
  • Favorable probability of success
  • Reasonable profit retention

One of Lucas’ key points is that – taxable investors and their advisors need to think differently. And by doing so, they can create tremendous value. You can build this symbiotic set of relationships among cashflow, tax and estate planning that is very powerful. Lucas’ analysist shows the impact of good tax and estate planning on an investment portfolio, and it’s easy to see that over 40 years’ time, a sound tax and estate plan is worth $610 for every $100 invested.

Another key point Lucas makes is – if you want wealth to grow over the long term, as a taxable investor, you must own stocks. Why? Bond coupon payments, short-terms capital gains, and equity dividends are taxed every single year.

Lucas makes a third key point in saying that over longer time horizons, stocks really aren’t so risky. The conventional measurement of risk is typically the standard deviation of returns of the asset, measured over one year. But you can actually measure the standard deviation of return over much longer periods of time. You must be willing to stick with the long term commitment to investing in assets that can feel uncomfortable (at first) to be invested in. Lucas advises to keep your long-term strategy in place through thick and thin.

Lucas’s next key point is this – don’t be misled by performance. Performance is typically measured by time weighted rates of return. Lucas’ research concludes that the rate of return an active manager has to generate to overcome the tax deficiency is about 150 basis points, which is a lot. For example, if we wanted to generate net 5%, what’s the gross rate of return a manager has to generate? In an index fund, it’s about 6.8% gross. In an actively managed mutual fund, it’s about 8.2%; in a private equity fund it’s about 10%, and in a hedge fund it’s closer to 13%. What is the probability that a hedge fund can generate that much alpha, in order for an investor to get 5% in my pocket? Probably not very likely, and might be relatively less attractive.

Finally, Luca’s fifth and final key point is – gain more value from active management. You would expect in looking at the universe of equity mutual funds, to generate slightly less than the market return, and not any alpha. You would also expect some sort of bell curve around the zero-alpha line. Lucas then takes one further cut and divides the world into high-tracking funds, that don’t look at all the index they’re supposed to be beating, and low tracking error funds, which tend to cluster their alphas around the performance of the index they are tracking. High-tracking error funds have a much broader range of relative returns to their indices.


Stephanie Simmons is a Relationship Manager at Family Office Exchange (FOX). She brings to her role a background in family office operations, having served in both a dedicated office and virtual family offices. As a senior relationship manager, Stephanie works with financial families to understand their objectives and provides guidance to help address their unique needs through the resources available at FOX.

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