$340K Tax Savings: Proactive Rebalancing Alerts Keeping Clients Invested

$340K Tax Savings: Proactive Rebalancing Alerts Keeping Clients Invested

Executive Summary

Richardson & Associates, a wealth management firm, faced increasing client anxiety during recent market volatility, leading to concerns about premature investment redemptions and potential tax liabilities. Golden Door Asset implemented a proactive rebalancing alert system that notified clients when their portfolios deviated from their target asset allocations. This resulted in a combined tax savings of $340,000 for clients who acted on the alerts, while also significantly reducing the rate of portfolio redemptions.

The Challenge

Richardson & Associates, a successful RIA managing over $500 million in assets, experienced a surge in client inquiries and anxiety during the first two quarters of 2023. Market fluctuations, driven by rising interest rates and inflation concerns, caused significant portfolio drift. For example, a client with a target asset allocation of 60% stocks and 40% bonds saw their portfolio drift to 70% stocks due to the relative outperformance of equities in early 2023 before the subsequent correction.

This drift created two primary problems:

• Increased Risk Exposure: The over-allocation to equities increased the portfolio's overall risk profile, making it more susceptible to market downturns. Clients nearing retirement or with shorter investment horizons were particularly vulnerable.
• Potential Tax Liabilities: Anxious clients, fearing further market declines, considered selling portions of their portfolios to reduce their equity exposure. However, many of these clients held highly appreciated assets in taxable accounts. Selling these assets would trigger significant capital gains taxes, potentially eroding their investment returns. A client with $200,000 in unrealized gains in a taxable account, facing a 20% capital gains tax rate, could owe $40,000 in taxes simply by rebalancing outside of a tax-advantaged account.

Before implementing Golden Door Asset's solution, the firm estimated that at least 5% of their clients were seriously considering liquidating portions of their portfolios, which would have resulted in substantial tax consequences. The constant communication required to address client concerns was also straining the firm's resources, taking up valuable time that could be spent on strategic financial planning. For example, advisors were spending an average of 10 hours per week responding to client inquiries related to market volatility and portfolio performance.

The Approach

Golden Door Asset partnered with Richardson & Associates to implement a proactive rebalancing alert system designed to mitigate client anxiety and minimize potential tax liabilities. The core strategy involved:

1. Defining Portfolio Drift Thresholds: We worked with Richardson & Associates to establish acceptable deviation thresholds for each asset class in a client's target asset allocation. For instance, a 5% deviation from the target allocation (e.g., 55-65% for a 60% equity allocation) triggered an alert. The thresholds were customized based on individual client risk profiles and investment objectives.

2. Automated Portfolio Monitoring: Using Black Diamond, the firm's portfolio management system, we set up automated monitoring of all client portfolios. Black Diamond provided real-time data on asset allocation and performance, allowing us to identify portfolios that had drifted outside their defined thresholds.

3. Proactive Alert Generation: When a portfolio drifted outside its threshold, the system automatically generated a personalized email alert. The alert included:

   • A clear explanation of the portfolio drift: It highlighted the specific asset classes that were over- or under-allocated.
   • An illustration of the potential risks: It explained how the drift could impact the client's investment goals and overall risk profile.
   • A detailed analysis of the tax implications of rebalancing: It estimated the potential capital gains taxes that would be incurred if the client sold appreciated assets to rebalance the portfolio. The analysis also included potential tax benefits of offsetting gains with losses, if applicable. This was presented as both a dollar figure and a percentage of the portfolio to make it easier to understand.
   • A call to action: It encouraged clients to schedule a consultation with their advisor to discuss the situation and explore rebalancing options.

4. Advisor Consultation and Customized Rebalancing Strategies: When a client contacted their advisor after receiving an alert, the advisor would conduct a thorough review of the client's financial situation and investment objectives. The advisor would then develop a customized rebalancing strategy, taking into account the client's tax situation and risk tolerance. This often involved:

   • Tax-Loss Harvesting: Selling assets that had declined in value to offset capital gains.
   • Asset Location Optimization: Holding tax-inefficient assets (e.g., high-dividend stocks) in tax-advantaged accounts and tax-efficient assets (e.g., municipal bonds) in taxable accounts.
   • Phased Rebalancing: Rebalancing the portfolio gradually over time to minimize the tax impact.

The strategic thinking behind this approach was to empower clients with information, provide them with a clear understanding of the potential risks and benefits of rebalancing, and encourage them to work closely with their advisors to make informed decisions. This proactive approach aimed to build client trust and confidence, reducing the likelihood of emotional decision-making during periods of market volatility.

Technical Implementation

The proactive rebalancing alert system was built using the following technical components:

• Portfolio Monitoring: Black Diamond was used for portfolio accounting and performance reporting. Its robust API allowed for automated data extraction and real-time monitoring of asset allocation. Custom reports were configured to identify portfolios that had drifted outside their defined thresholds based on a multi-factor rule engine.
• Rebalancing Calculations: Black Diamond's built-in rebalancing tools were used to calculate the optimal trades required to bring each portfolio back to its target asset allocation. The system considered factors such as transaction costs, tax implications, and minimum trade sizes. We utilized a custom formula within Black Diamond to estimate capital gains taxes based on the client's tax bracket and holding period. This calculation was integrated into the alert notification. The formula considered both short-term and long-term capital gains tax rates.
• Email Notifications: Mailchimp was used to send automated email notifications to clients. Personalized email templates were created to ensure that each client received a tailored message that addressed their specific situation. The templates included dynamic content that populated information such as the client's name, portfolio value, asset allocation, and estimated tax liabilities.
• Integration and Automation: A custom integration was developed using Python and the Black Diamond API to automate the entire process. The script ran nightly, extracting portfolio data from Black Diamond, performing the rebalancing calculations, generating the email alerts, and sending them via Mailchimp. The script also logged all actions and errors to ensure proper monitoring and troubleshooting.
• Data Security: All data was encrypted both in transit and at rest. Strict access controls were implemented to protect client information. Regular security audits were conducted to ensure compliance with industry best practices.

Results & ROI

The implementation of the proactive rebalancing alert system yielded significant results for both Richardson & Associates and their clients:

• Tax Savings: Clients who received and acted upon the rebalancing alerts realized a combined tax savings of $340,000. This figure represents the estimated amount of capital gains taxes that clients would have paid if they had prematurely sold their appreciated assets without proper planning. This translates to an average tax savings of $5,667 per client who rebalanced based on the alerts (based on 60 clients actively rebalancing after receiving alerts).
• Reduced Redemption Rate: The rate of portfolio redemptions among clients who received the alerts was significantly lower than the firm's overall redemption rate. Only 1% of clients who received alerts redeemed their portfolios, compared to a historical redemption rate of 3% during periods of market volatility. This represents a 66% decrease in the redemption rate.
• Increased Client Engagement: The proactive alerts sparked more frequent and meaningful conversations between clients and their advisors. The number of client consultations increased by 20% in the months following the implementation of the system. Clients felt more informed and empowered to make informed decisions about their investments.
• Improved Advisor Efficiency: By automating the process of identifying and notifying clients about portfolio drift, the system freed up advisors' time to focus on more strategic financial planning activities. Advisors reported a 30% reduction in the time they spent responding to client inquiries related to market volatility. This allowed them to dedicate more time to tasks such as developing financial plans, meeting with prospective clients, and staying up-to-date on market trends.
• Enhanced Client Retention: The improved client engagement and reduced redemption rate contributed to higher client retention. Richardson & Associates saw a 2% increase in their client retention rate in the year following the implementation of the system.

Key Takeaways

1. Proactive Communication is Key: By proactively communicating with clients about portfolio drift and potential tax implications, advisors can build trust and reduce anxiety during periods of market volatility.
2. Automation Enhances Efficiency: Automating the process of portfolio monitoring and alert generation frees up advisors' time and allows them to focus on more strategic activities.
3. Personalized Alerts Drive Action: Tailoring email alerts to each client's specific situation and providing clear, concise information increases the likelihood that they will take action.
4. Tax-Aware Rebalancing Minimizes Liabilities: Incorporating tax considerations into the rebalancing process can significantly reduce clients' tax liabilities and improve their overall investment returns.
5. Data-Driven Insights Improve Outcomes: Leveraging data analytics to identify and address potential risks can lead to better client outcomes and increased client satisfaction.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors proactively manage client risk, improve efficiency, and enhance client relationships. Visit our tools to see how we can help your practice.