Bill Harris is the CEO & founder of Evergreen Wealth. He’s founded/led eight fintech companies, including PayPal, and Personal Capital.
Over the past 150 years, the world of individual investing has seen three significant developments: the brokerage account, the mutual fund and the ETF. Investors are now witnessing the rise of a fourth generation: the tax-managed account.
The first generation of investing was the brokerage account, a step change from signing a legal contract each time you bought a share. The second was the mutual fund, professionally managed and easily accessible for purchase. The third was the ETF, offering lower costs and greater diversification than a mutual fund. A new contender is the tax-managed account, which offers the benefits of an ETF plus personalization and potential tax savings. It combines individualized goals, customized portfolios, daily rebalancing, direct indexing and other tax-optimization strategies designed to deliver higher risk-adjusted after-tax returns (full disclosure: Evergreen Wealth offers this solution).
It’s still early, but the emergence of tax-managed accounts is visible across the investment industry, from wealth management firms to robo-advisors to retail giants Fidelity, Schwab and Vanguard—all of which offer some version of this approach.
The percentage of assets managed in this way is still small, but the green shoots are there. In my experience, it takes about five years for new financial technology to be widely accepted and about 10 years to capture a significant share of the broader market.
The Evolution Of Investment Management
“Investment management is not art, not science, it’s engineering,” said Charles Tschampion, who managed the GM pension fund. Driven by advancing technology, the job of engineering investment portfolios has matured from qualitative guesswork to quantitative analytics.
1. Brokerage Account
The ability to trade stocks from home sparked a surge in capital formation that fueled America’s industrialization in the 20th century.
In the late 1800s, the shiny new technologies that enabled local brokerage houses to receive sort-of-real-time quotes by Morse code were the telegraph and the ticker-tape machine—quaint precursors to the internet, which now transmits data 1 trillion times faster. To this day, storied old-line brokerage firms like Merrill Lynch are still referred to as “wirehouses.”
2. Mutual Fund
The second generation was the mutual fund, which offered professional investment management wrapped in a simple-to-buy package. It marked the shift from a craftsman model, where your stockbroker picked stocks based on hunches and tips, to the mass production of identical, one-size-fits-all investments—perhaps the very first information factory. As Henry Ford said of his own factory, you “can have a car painted any color … so long as it is black.”
The first modern mutual fund appeared in 1924, but it didn’t take off until the IBM System/360 mainframe fueled explosive growth in the late 1960s.
3. Exchange Traded Fund
ETFs are traded in real time on stock exchanges. This can be an advantage for investors but a significant computing burden for the firms that operate the ETFs and make basket trades to ensure an ETF’s price stability.
4. Tax-Managed Accounts
The tax-managed account marks the leap from mass production to mass personalization. Selling a massive volume of a single security, such as an ETF, in real time is one thing. The computing required to perform daily multi-objective optimization for soon-to-be millions of individually designed portfolios, each with hundreds of securities, is quite another matter. A single tax-managed account can require up to 100,000 buy/sell decisions a year.
For 10 years, I oversaw the development of TurboTax, which saves millions of Americans countless hours. But it doesn’t save money—it records what happened last year but cannot change it. So, I built tax-planning software to help taxpayers save on taxes throughout the year, but selling it was almost impossible.
That’s when I learned the difference between “must-dos” like tax prep and “should-dos.” Every investor should do tax planning, but few do. A tax-managed account does it for you and likely does it better than you could do yourself.
The tax-managed account inherits the benefits of prior generations but adds hyper-personalization and comprehensive tax optimization. It is precision-engineered for each investor based on their investment objectives, risk/return appetite, current assets and tax posture. It can deliver higher after-tax performance than the legacy methods.
With a tax-managed portfolio, you don’t own a single “pooled” security; you own hundreds of individual securities, allowing you to personalize your holdings along many dimensions. High diversification helps maximize your risk-adjusted return.
Owning individual stocks allows your investment advisor to micromanage each security and each tax lot daily, seeking every ounce of potential tax savings. Multiple tax-reduction strategies can be deployed simultaneously, guided by automated algorithms and AI. The result is a portfolio uniquely designed for your needs that can deliver higher after-tax performance than a comparable ETF.
Challenges And Considerations
Tradition is likely the biggest obstacle to impede the adoption of tax-managed portfolios. Many investors and brokerages are accustomed to traditional investment methods that are rooted in the past.
At the same time, most financial advisors remain tethered to presenting clients with spreadsheets that show gains and losses. Tax-managed portfolios require collaboration with an advisor or firm that understands how to utilize today’s sophisticated tools and has access to the necessary technology.
Finally, a tax-managed portfolio may not be the best choice for certain investors, particularly those with limited income or a more conservative investment approach. Those investors might be best served by traditional investment channels.
The Future Of Individual Investing
Five years from now, tax-managed accounts may well be recognized as the next evolution of individual investing. While some in the industry still think of them as impractical experiments—and many investors aren’t yet aware they exist—momentum is building. I witnessed a similar change 15 years ago when I started one of the first “hybrid” investment advisors combining human advisors with digital apps. The hybrid model is widely followed today.
Ultimately, technology only executes the instructions it’s given. But it can execute the fundamental principles of investing—risk and return, diversification, correlation, factor analysis and tax optimization—with rigor and speed like never before. It will only accelerate.
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