Conventional Wisdom on Wall Street

Conventional Wisdom on Wall Street

By Gil Baumgarten, Segment Wealth Management, LLC

Wall Street’s success is often predicated upon the belief that they can predict the future through sheer intelligence and insight. Even if so, I contend that the mere pursuit of investing in the right place at the right time comes with enough disadvantages to neuter the success. Let me explain.

Brokerage firms love to tell clients about their ability to choose funds or managers whose methodologies are market-beating.

The truth is that most methodologies often just align with market dynamics that are random but cyclical. The most recent form of this is the decade-long advantage of growth stock investing over its value counterpart. Now, value is suddenly on a tear, and the cycle repeats. This could appear as though the IQ of value managers is skyrocketing, while the truth is that it’s merely a repeating but unpredictable cycle. This dynamic often manifests a manager or fund swap recommendation because the theoretical appeal of having all of our portfolio in the right spot is highly appealing.

Yet, we often fail at this exercise for two reasons. The first reason is that the marketplace sends mixed messages along the way, and most reversals are sudden with little notice given. We rarely have the stomach to make these changes at the right time. The second and more important reason is that the tax cost from the friction of the process is profound. The realization of taxable gains in the swap from one strategy to another can reduce future returns by one-fourth due to lost compounding on taxes paid too soon. This “let your winners compound” mindset also plays particularly well with philanthropic strategies.

More profound still is the loss of the benefit of the Step-up in Basis Rule, which forgives capital gains taxes at each successive owner’s death. This rule alone could triple the advantage of perennial deferral of taxes. Resetting the cost basis by selling old positions and buying new ones drains the account of prior gains and cumulatively robs the account of its single greatest potential advantage: tax-free forgiveness of capital gains. Add in some charitable giving of low basis stock as another advantage of this mind-shift, and you have a repeatable advantage that the prophets cannot match.

Allow me to propose that you split the difference and follow growth and value strategies in tandem, perpetually. Use low-cost, low-turnover strategies designed to reduce the certainty of taxes and fees rather than pursue the uncertainty of other less valuable and non-repeatable performance advantages.

Your broker won’t be happy about this, but your grandkids will be ecstatic.

For more information, please contact Haley Parmer at (713) 800-7158 or Haley.Parmer@segmentwm.com.

Read more of Gil Baumgarten’s articles at Segmentwm.com/blog.