The Tax Clock Is Ticking

Year-end tax tips for advisors and their clients

Ric Edelman: It's Friday, December 1st. Coming up on today's show, it's time for year-end tax planning. We're going to talk tax strategies with folks from Invesco. I'll also explain what a public key is.

We've got some good news on the advance of medical technology that's curing cancer. The Food and Drug Administration has just given approval for focused ultrasound to treat liver tumors. This is the ninth use of focused ultrasound that's been approved by the FDA. The technology destroys tumors in the liver without harming the surrounding tissue. And the technology is noninvasive, meaning there's no surgery. It's an outpatient treatment with no pain, no anesthetics, and no recovery period. The cure is instant and permanent. The technology was tested on 44 patients who had a variety of liver tumors, including metastatic tumors in the liver that had started in the colon, rectum and breast. The success rate 95.5% with minimal adverse events. Liver cancer has tripled in the last 40 years, and this is the first time we've got a treatment that is so powerful.

The success also lays the groundwork to use this tech to treat cancer in the pancreas, kidneys and uterus. And that's not the only recent announcement about focused ultrasound. GE and Novo Nordisk are doing studies that so far look like the tech helps people with Type 2 diabetes and obesity. The ultrasound stimulates the nervous system so it can treat disease. 

Early stage trials shows that it impacts glucose metabolism in people with diabetes. That would replace the need for insulin. 540 million people around the world have diabetes, and 90% of them have Type 2. We spend a massive amount of money treating people with this disease. This would be a game changer.

And yet there's even more news about focused ultrasound in the treatment of disease. The FDA has also approved it for brain tumors. The technology uses focused ultrasound plus microbubbles to temporarily and non-invasively open the blood brain barrier without surgery, so that drugs can be delivered to tumors in the brain. The blood brain barrier is a protective layer of the brain, but it's so protective that it prevents drugs from reaching their targets. Focused ultrasound gets through the blood brain barrier so that drugs can do their job, and the procedure is painless and portable. The patient sits in a chair with no anesthesia. It's an outpatient treatment with instant results. And so now they're looking at using this tech to treat a lot of brain conditions glioblastoma multiforme, brain metastases, Alzheimer's, Parkinson's and other neurological diseases. Pretty exciting of what's coming.

With the tax year ending, there are ways to reduce your tax liability. We're going to give you the action steps you can take with professionals from Invesco. That's next on The Truth about Your Future. 

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Exclusive Interview with Invesco's Lili Jiang and Ryan McCormick

Ric Edelman: You're listening to the Truth About Your Future. I'm Ric Edelman, you know, this is a show about your future. Normally, we're talking about your long-term future things that are going to be affecting you ten, 20, 30 years out from now. I want to talk about something that's going to be affecting you 10 or 20 days from now. We are in the midst of the holiday season. It is year-end fast approaching, and while I know you're terribly busy with all the stuff normally that we're dealing with as we deal with the holiday season and year end, there's one other big thing we've got to deal with taxes.

Well, I know you don't want to talk about taxes, because that doesn't sound like a very happy holiday kind of a thing to do. But trust me, you're going to be really happy you're paying attention to this, because this is a terrific way that you can really be of tremendous value to clients at year end. And if you are an investor, a terrific way that you can lower your taxes.

And to help us figure all this out, I'm very happy to bring on to the program. Lili Jiang and Ryan McCormick. Lili is the ETF and Index Strategy Specialist at Invesco, and Ryan is the Senior Factor and Core Equity Strategist. Invesco, of course, one of the largest ETF and mutual fund providers in the world. And there is a huge opportunity here for dealing with lowering taxes in the world of ETFs. And Invesco is not just a product sponsor, not just one of the world's largest asset managers, but Invesco offers tax insights that can help you as a financial advisor, manage your client portfolios and minimize the capital gain distributions, taking advantage of things like tax loss harvesting techniques and implementing tax efficient investing with ETFs. So Lili and Ryan, thanks so much for joining me on the show today.

Ryan McCormick: Thanks for having us, Ric.

Lili Jiang: Great to be here.

Ric Edelman: So what are the strategies that we really need to be focusing on this time of year? Ryan, let's start off with you.

Ryan McCormick: Well, you know, I think as we march closer to year end, it's important to be mindful of where you can kind of minimize your tax bill. It's a problem that we can address now. Right. And I think when we look on the active mutual fund space, there are repeat offenders when it comes to capital gains distributions. And those capital gains distributions can give clients an unwanted tax bill. We offer a suite of ETFs that historically have paid less from a capital gains perspective, and I think implementing them can help us be very forward thinking when it comes to managing tax liabilities for this year and in future years.

Ric Edelman: I think that most folks are just thinking that, you know, ETFs, they are long term oriented investments, and it's kind of a set it and forget it kind of approach. But that mentality doesn't always allow you to take full advantage of the tax saving strategies that are available, right?

Ryan McCormick: Well, I mean, I think there's a couple of ways that you can look at this, right? One would be from the tax loss harvesting perspective, trying to find underperforming investments that you can sell and book that tax loss carry forward.

Ric Edelman: The interest rates have skyrocketed, which has created an entirely new environment for the bond market. So this is creating an unusual opportunity to engage in tax loss harvesting, as you mentioned. But walk us through the mechanics, if you would, Ryan. How does it actually work? What do I do as an advisor to figure out how to take advantage of that idea?

Ryan McCormick: What you're going to want to do is look at your cost basis versus where your investment sits today. And if there's a loss from when you purchased it, you could sell and lock in that loss to offset gains of other funds that you've sold for a profit.

Ric Edelman: Too often I find that advisors say they don't want to sell an asset that has gone down in value because they don't want to be out of the market. They don't want to have to wait 30 days to rebuy it. Under tax law, if you rebuy the same asset within 30 days, you can't take the tax loss. They don't want to be out of the market. What they fail to realize is that you don't have to be out of the market. You just go from investment A to investment B that is very similar to investment A; you get to maintain your allocation essentially while securing the tax loss. It's a win-win proposition.

Ryan McCormick: Yeah, absolutely. And I think we see that quite a bit.

Ric Edelman: Lili, I want to bring you in this conversation because there's an interesting element that Ryan kind of referred to that I think demands elaboration. It's the notion of profits. We tend to think very simplistically, that investments are either profitable or unprofitable. What we don't often realize is that profits come in a couple of different flavors, particularly in the context of capital gains. An investor may say to themselves, “I bought an investment. I still own it. I haven't sold it. I therefore don't have any tax profits I need to worry about.” They're not paying attention to capital gains. So give us some back story on the impact of capital gains inside mutual funds and ETFs.

Lili Jiang: That's a great topic. Ric. Capital gains are typically what we would come across if we're buying and selling securities. But capital gains distribution can actually happen when you own a mutual fund. Typically they happen around the end of the year. And how they happen is when the mutual fund portfolio managers are buying and selling securities throughout the year, they can have gains that they then have to pay out at the end of the year. So you may actually be holding this mutual fund. You may not have sold it at all. And whether it has gone up or gone down, that's irrelevant of whether those capital gains get paid out. So in a good year, we may have gains in a bad year, we may have gains. And those just happen inside of the portfolio.

Ric Edelman: That's crazy. In a good year I may have gains. In a bad year, I may have gains even though the fund itself might be down in value, you still have a taxable gain you've got to pay taxes on, because the fund distributed a capital gain on the assets that sold for a profit. That could be pretty frustrating for an investor, and I think pretty difficult for an advisor to explain to that investor. I mean, just imagine that phone call. “Sorry you lost money on the investment, but you owe taxes.” I mean, that's about as bad a combination as it gets. And so it would seem to me that the best strategy for the adviser is to give their clients investments that are not likely to pay out those capital gain distributions. Can an investment adviser anticipate such investments? Can you reasonably say, yeah, this investment over here is far less likely to create that problem than that investment over there. Can it be that simple?

Lili Jiang: Yeah. So I think it is one of the really big reasons why ETFs have also gained a lot of popularity over the last decade. So the ETF structure actually helps to minimize those capital gains distributions. It's another reason why, typically this time of year, ETFs tend to get a big surge in flow. That’s because we see folks selling their mutual funds and actually swapping to an ETF that has similar exposure, but also avoiding the capital gains distributions the mutual fund themselves might be holding. The ETF itself is able to avoid a lot of these cap gains due to its structure. So the ETFs actually have a system called either accretion or redemption. It is basically how the shares are created or redeemed out that helps to avoid those capital gains distributions. That's not to say that ETFs won't pay a capital gains distribution, but historically, what we've seen is that the chances are much lower and the gains that are paid out are typically much lower as well.

Ric Edelman: And I think this is exactly right, as you said, why ETFs have exploded in popularity over the past decade because they are inherently more tax efficient. And when you have two investments that are basically the same investment, one is run by a mutual fund, one is run and the structure of an ETF, but they have the same fund manager buying the same securities in the same way. And one of them is inherently more tax efficient than the other. It's kind of obvious, isn't it, which the investor ought to be buying. So that just seems to make a lot of sense. Give us an idea of why one ETF would be more likely or less likely to pay out capital gains distributions. What's going on in that ETF that would cause that to occur?

Ryan McCormick: To Lili's point, when you're selling mutual fund shares, you're going directly to the fund company. They in turn need to go and sell securities within the portfolio. Thus either booking that gain or loss. You can have what's called an in-kind transfer, where you're transferring shares of an ETF to an authorized participant in the marketplace in exchange for the underlying securities, or vice versa. They'll transfer you shares of the ETF for the underlying securities, and the portfolio manager is not buying and selling those individual positions, much like a mutual fund would. Now, there are instances within ETFs with high turnover, sometimes with some more illiquid securities where that in-kind transfer process cannot fully shelter from capital gains. But because of that, because of the notion that many ETFs. Are generally lower turnover than some of their active mutual fund counterparts. It does enable them to pay out less from a capital gains perspective, and we have funds at Invesco that have over ten year track record of never paying a capital gain distribution. So we like to say it's not impossible, but you're far less likely to get a capital gain distribution within an ETF.

Ric Edelman: And it's not just going back to a point Lili made earlier about the difference between profits and taxes. It's not just capital gains that can trigger taxation. Dividends as well can trigger taxation. So you've got some companies that pay dividends and other companies that don't pay dividends. So is there a way that you can anticipate what the dividend distributions are going to be from a given ETF? 

Ryan McCormick:  You have a halfway decent idea of what the dividend for the year looks like looking at your SEC yield. But again, if the dividend is something that you know you're worrying about from a tax perspective, keep in mind funds that maybe avoid higher dividend payouts.  

Ric Edelman:  Lili let's put numbers to this conversation. What would you say is a range of dividends that various ETFs may distribute? Obviously some are going to be zero, right? They don't pay any dividends at all. What's the high side for an equity ETF that its dividend distribution might be.

Lili Jiang: Yeah. And as you mentioned we have equity ETFs that range from zero. Or we can actually have funds that range in the double digits up to 11%. So you can definitely look for income inside of an ETF for sure.

Ric Edelman: But what about on the capital gains side. We've talked about the importance of avoiding capital gain distributions because those are unexpected. We don't know when the fund is going to distribute them. We don't know how much it's going to be. And it always comes as a tax surprise toward the end of the year. ETFs and mutual funds are busy around this month issuing their annual capital gain distributions, and they always come as a bit of a surprise. What's the range there? If the range in dividends is from 0 to 10, what's the range in capital gain distributions that you've seen.

Lili Jiang: Of the Invesco ETF? We've had very few in our lineup that pay a capital gains distribution if any; very, very small percentage. The range could be anywhere between zero all the way as high as even 30% capital gains distributions.

Ric Edelman: And this is really why advisors need to pay attention to this, and also the timing of their investments on behalf of their clients. Because if you end up in a mutual fund that's paying a 30% capital gain distribution, you have no idea that it's coming and that distribution is occurring regardless of how long the client owned it. In other words, that might be a client who bought that fund ten years ago. It might be somebody who bought the fund two weeks ago. As long as they're owner of that fund, as of the record date, they're going to see that 30% capital gain distribution. Just imagine this. They put 100 grand into the fund. They do it a month ago. The fund then distributes a 30% capital gain distribution. That's a $30,000 line item that they're going to have to report on their tax return in April and pay taxes on that $30,000 on an investment that they've owned for a matter of weeks. This is something that can shock somebody to no end.

Lili Jiang: Yeah, it's definitely a big surprise for a lot of folks, right? Capital gains happen every year and we see it year in and year out. And I think this is another reason why ETFs continue to gain popularity.

Ric Edelman: And so it really comes down to recognizing that if you want to pay attention to taxation, which people ought to do, remember it's not what you earn that matters. What you keep that matters in the world of investing, net of tax, we really need to be recognizing that ETFs have a huge advantage over mutual funds, all other factors being equal because of this tax angle. So, Ryan, what are the different ways that advisors and their clients can add ETFs to their portfolios?

Ryan McCormick: So I think when we're looking specifically for let's say capital gains distribution offenders, let's say you have a large cap growth mutual fund and let's look at a large cap growth ETF replacement. They look very similar in terms of growth. And then Invesco is well known for its RSP or S&P 500 Equal Weight Fund ETF. It's the first smart beta ETF launched in 2003. Also has not paid a capital gain distribution in its 20 year history. We have a Dynamic Multifactor ETF, ticker OMFL. It's been around for five plus years. Also has not paid a capital gain distribution in its history. It looks on a monthly basis at a signal to determine what economic regime we are in, and it has the potential to move around quite a bit when you're looking at a calendar year. So it almost has this active feel and that it has the potential to move around quite a bit. And for those investors that are big believers in active management, I think would be a really good replacement that gives a similar look and feel in many cases when looking to replace a capital gain distribution offender.

Ric Edelman: And that's really impressive information that you're providing. And you've peppered a lot of the conversation there, Ryan, with the notion that these portfolios are not only very robust in their construction. I mean, first and foremost, you're emphasizing the portfolio management, you know, the security selection within those funds. But at the same time, you're weaving in the notion that taxes matter and you're paying attention to the tax efficiency of these funds. I mean, Invesco is managing, what, $1.3 trillion now on a global basis, making you clearly one of the largest sponsors of ETFs and mutual funds, and certainly here in the US. But along the way, you've all become experts in tax. Talk about that journey, Lili, of recognizing that in investing, you've got to pay attention to taxes. You can't merely look at the security and analysis without a viewpoint on tax.

Lili Jiang: Yeah, absolutely. When I speak to advisors, I always ask them, what are there certain things that you look at? And I think some of the things that come to mind might be liquidity, might be fees. But one of the things definitely too is the tax efficiency of that ETF. It's actually one of the things here at Invesco that we track their performance on throughout the year is whether they're able to keep that ETF tax efficient as possible. So I think it's really important. Only about 4% of our ETFs paid gains last year. And we have over 240 ETFs. So I think it's a pretty consistent number that we've been able to produce year in and year out. So I think it's one of those things that we really try to educate on and really try to adhere to as a value proposition for our ETF business.

Ric Edelman: And by extent, you're not just doing this internally. Invesco has produced a lot of tools and resources for financial advisors and investors. There's one document in particular that I really like called How to Avoid the Downside of Capital Gains. You can download it and read it for free. The link is in your show notes today. But in addition to that you have a variety of other tools and resources. So Lili, tell us a little bit about some of the tools that you provide to advisors and investors in the area of tax.

Lili Jiang: So I know we're in the midst of sort of football season right now, but we're really in the midst of our Super Bowl here inside of Invesco. So what we have is we have a great team. It's all hands on deck. We have a database that will actually help advisors identify and track what capital gains distributions might be occurring inside of their portfolios. So all advisors have to do is reach out to their contact at Invesco, send a list of the tickers that they own, and will actually send back a customized report every week to show you what, if any, capital gains distributions have been announced. For that holding, we'll send the record date, the pay date, the estimated long and short term capital gains distribution. And we also have some standardized reporting in terms of performance in there as well. So it's a really holistic picture of what you own.

Ric Edelman: So I encourage you to contact the folks at Invesco, because I think the wealth of information that will help you be a better advisor, help you be better service to your clients can really make a difference in your practice. We've been talking with Lili Jiang. She is the ETF and Index Strategy Specialist for Invesco and Ryan McCormick, the Senior Factor and Core Equity Strategist at Invesco. Thank you both for spending time with us here today. Really appreciate it.

Ryan McCormick: Thanks, Ric.

Lili Jiang: Thanks, Ric.

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Crypto Explainer: Private Keys

Ric Edelman: Welcome back to The Truth About Your Future. The world of digital assets and blockchain technology has generated a whole new glossary. One question I get often is about all of these keys. Private keys. What are those? Well, if there's a private key, you just kind of got to go figure. There's got to be a public key too, right?

So let's understand what these public keys and private keys are all about. In the world of crypto, it's really very simple. A private key is just another phrase for password. When you buy digital assets, you do so by getting a wallet. That is another way of referring to an account. You open an account. You open a wallet, and in that wallet you buy your digital assets, bitcoin, Ethereum or what have you. But how do you safeguard your wallet? How do you prevent other people from getting into your wallet? Well, just like you have a password for your email, you have a private key for your wallet. But what about the public key?

Well, think of it this way. With email, you give people your email address. That's your public key. That's how you send people emails. It's how they send emails to you. Your password is how you access the emails you receive and it's how you control your email account. In the world of crypto, with your wallet, your private key is your password. And that's how you control and protect your crypto account. But if you want to send crypto to somebody, or if you want somebody to send crypto to you, you give them your public key. Kind of like your email address. It's really that simple. Email addresses and passwords are the same thing as public keys and private keys. 

Ric Edelman: That's it for today. A reminder that the latest episode of Jean’s podcast came out yesterday. It may just make a healthy difference in your life. You can listen to Jean’s show wherever you get your podcasts, and you'll find the link in today's show notes. Enjoy the weekend. See you Monday.

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