Investment Management

Tax-smart tips to rebalance your clients’ portfolios

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If you haven’t rebalanced some of your clients’ portfolios recently, you may be overdue. After all, in the five years ended September 30, 2017, the CRSP US Total Market Index was up a cumulative 94.3% while the Bloomberg Barclays U.S. Aggregate Float Adjusted Index was up only a cumulative 10.8%, so it’s not hard to see how clients’ portfolios may no longer match their target allocations.

Still, you know that for clients who hold substantial taxable accounts, rebalancing can trigger capital gains taxes and, perhaps, additional net investment income taxes. Here are a few suggestions to help tax-sensitive clients maintain their risk profile through rebalancing:

Use your clients’ tax-advantaged accounts

Consider coordinating your rebalancing across all your clients’ portfolios, including assets held outside your management, such as 401(k) plans. If rebalancing is done through tax-advantaged accounts, there are no tax consequences.

Use required minimum distributions (RMDs) strategically

Clients over the age of 70½ will need to take mandatory distributions from their tax-deferred retirement accounts.1 While the amount to be taken is mandated, the funds from which it is withdrawn should be guided by you. Here are a few other things to consider:

If a client is taking RMDs for spending needs, then the distribution should come from the overweighted asset class. Since any withdrawals of earnings and pretax contributions will be taxed, it’s beneficial to pare back the part of the portfolio that is heavy relative to the target asset allocation.

If the client is fortunate enough to not need the RMD for spending needs and intends to reinvest the net proceeds in a nonretirement account, be mindful of the asset allocation mix while investing in tax-efficient investments, such as broad-market stock index funds, or municipal bond funds if the client is in a higher marginal income tax bracket.

For a charitably inclined client, a good option is to take advantage of a qualified charitable distribution (QCD).  For example, the client may have his or her 2017 RMD made payable to the charity of the client’s choice (provided it meets the IRS definition of a qualified charity), and then designate it as a QCD on his or her tax return. The client will have satisfied the RMD without the tax consequences, and the charity will get the full benefit—all while rebalancing!

Direct cash flows

It will soon be the season when many actively managed equity funds distribute capital gains and year-end dividends, and even index equity funds regularly kick off dividends.

You may have positioned many of your clients to automatically reinvest those distributions and dividends. But if they need to rebalance, then consider directing those to cash, and then using those funds to achieve rebalancing.

Similarly, if clients are investing new money in their portfolios, look at their asset allocations. This is a great time to direct cash flows to the underweighted asset class.

Clients should gift with their hearts and their wallets

Charitable giving can be an effective strategy outside your retirement accounts, too.

Gifting appreciated assets from taxable accounts to charity has three potential benefits—tax efficiency, rebalancing, and cost-effectiveness. With the equity markets’ strong performance so far in 2017, and in recent years, it makes a lot of sense to give appreciated securities in lieu of cash donations. Clients will get the full deduction value of the donation without paying capital gains taxes or transaction fees.

Your clients can also take advantage of annual gifting to friends or family, though this comes with some caveats. In 2017, a client can gift up to $14,000 to as many individuals as the client likes (up to $28,000 if he or she is married and files jointly) without gift-tax consequences. You can also advise your clients to consider gifting low-cost-basis shares instead of cash. Doing so can help with rebalancing and allow a client to transfer the gain to the client’s donee, since the taxable basis will carry over to the donee. However, keep in mind any estate planning considerations, especially for older clients. Because beneficiaries who inherit assets will receive a step-up in basis, you’ll want to consider any gifting in the context of the client’s broader estate plan.

I’m the first to admit that rebalancing for many clients can involve some behavioral coaching, because rebalancing is often counterintuitive and involves selling investments that have performed well. Our research on rebalancing shows there is no meaningful difference whether a portfolio is rebalanced monthly, quarterly, or annually, but the resulting costs increase significantly with the number of rebalancing events, so semiannually or annually appear to be fine solutions.

The real payoff of rebalancing, however, comes from maintaining the risk profile of your clients’ portfolios, which can help clients be less anxious during times of volatility.

For more, listen to our recent episode in Vanguard’s Investment Commentary series, How to handle RMDs and other year-end planning tips, featuring Maria Bruno.

Special thanks to my colleague Jenna McCleary for her contributions to this blog post.


1 If a client is still working, he or she can defer RMDs from employer-sponsored plans.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

We recommend that you consult a tax or financial advisor about your individual situation.

Doing what’s right for the client…always

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As part of my job as head of the RIA Group at Vanguard, I spend a lot of time talking to advisors and learning how they provide great service to their clients.

In a previous blog post, I listed four key areas that I believe set top advisors apart from their peers. From time to time, I want to call out firms I’ve visited that are using these best practices as part of their everyday business.

Recently I had the chance to chat with Harold Williams, president and chief executive officer of Houston-based, full-service RIA Linscomb & Williams (L&W), and to ask him about L&W’s value proposition. What really stood out to me was the firm’s approach to client relationships. First, L&W decided it was critical to start acting as a fiduciary in 1984! And it has been doing so ever since.

No extra credit for treating clients right

Since it was founded in 1971, L&W has emphasized the importance of building relationships with its clients.

“I’ve learned that you don’t get extra credit for treating clients right. You get extra credit for proactively communicating with clients and understanding their needs,” Williams told me.

Connecting with clients following a natural disaster

L&W’s ability to connect with its clients was never more apparent than when Hurricane Harvey hit Southeast Texas in August.

Williams shared with me that shortly after the hurricane hit, the firm emailed all its clients, but this email was different because it didn’t focus on traditional financial topics. It provided helpful links to organizations providing disaster relief, along with tips for filing insurance claims. Little things like this—while they have nothing to do with investing—go a long way to gaining a client’s trust and cementing the relationship. The L&W team was personally affected by the storm yet made the effort to go above and beyond for clients during this difficult time.

Williams told me how one client who’s now retired and living in North Carolina contacted the firm not long after the hurricane to ask whether the L&W team and its families were okay.

“This client has been with the firm since the early ’70s. He, like many of our clients, views us as a trusted friend,” Williams said. “You have to cultivate that trust.”

Client trust drives business success

By getting to know your clients and what’s important to them, you’ll increase their level of trust in you. Our research shows that clients who have a high level of trust are more than 12 times as likely to recommend their financial advisor to a friend or family member compared with a client with a low level of trust. That’s proved true for L&W, with two-thirds of their new clients coming to them through referrals.

I love the opportunity to talk with top firms like L&W. I always learn something from these interactions, and viewing this kind of research reinforces a key lesson.

Investment performance, while important, isn’t going to generate client loyalty in isolation. Making the client experience exceptional, proactively communicating with clients, and talking to them about things outside of what’s going on with their portfolios are the actions that will form an unbreakable bond.

How do we know this is true? We asked investors, what would break the trust they have with their advisor? These are just a few of the reasons they gave:

  • There was a lack of timely communication.
  • The advisor was condescending.
  • The advisor didn’t pay attention to them or their portfolios.
  • The advisor didn’t make them feel that their business was important.

“If you only talk to clients when they contact you, they’re going to start to wonder ‘How long would it be before my advisor reached out to me if I didn’t pick up the phone? Would he or she ever? Does the advisor care at all?’ ” Williams said.

I believe you, Harold! L&W’s track record spanning almost five decades more than proves this out.

Technology isn’t a threat—It’s an opportunity

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Are we dinosaurs amid all this disruption?

I’m just back from Florida and the 2018 Inside ETFs conference, where in between deep conversations about market returns, factors, and bitcoin, there hung this question about advisors’ livelihoods in a world that grows more digital by the day. It’s a concept bigger than ETFs, and it’s a message we all need to hear: Change, or forever be changed.

You need to rethink the tasks you do every day.

Tim Buckley, my new boss and Vanguard’s new CEO, broke it down pretty explicitly in his opening keynote Inside ETFs address. Your job of looking out for your clients’ livelihoods is here to stay, but you need to rethink the tasks you do every day. While this is daunting, he pointed to the path forward and the amazing opportunity of it all.

A fair amount of gloom-and-doom research has stated that millions of jobs are susceptible to automation and will just disappear. We fundamentally disagree: While there are tasks today that will be automated away, jobs will evolve to increasingly revolve around advanced, uniquely human tasks, such as strategizing and solving problems.

So what are automation’s implications for advice? No doubt about it, computers have just about perfected portfolio construction, driving the core costs of advice down, but the data show that what clients really want is something computers can’t provide. And therein lies the opportunity.

Technology and automation aren’t threats at all. They are the gateway to future success, perhaps much more success than even the best advisors could build on their own. They free up time to focus on where you can add the most value: behavioral coaching, customized retirement income solutions, long-term care planning, insurance coverage, estate planning, and the like.

What’s in it for you? Deep bonds. You’ve invested a lot of time getting to know your clients inside and out to provide creative, custom solutions. Where does that get you? You’re no longer a price comparison; clients don’t even think about not having you at their sides. And they tell their friends, families, and colleagues just how good you are.

And enough gloom on where advice is headed; advisors should be energized.

We shouldn’t fear or fight technology; we should embrace it to do things better, faster, and cheaper. And enough gloom on where advice is headed; advisors should be energized. Let your value shine in creativity, coaching, and customization—things a computer will never be able to do. You will thrive.

I encourage you to read The evolution of Vanguard Advisor’s Alpha®: From portfolios to people, the latest chapter in our ongoing effort to help you understand and articulate where your value lies. There you’ll find data showing what clients truly value, as well as our thoughts on increasing your value as the industry continues to evolve.

In times of volatility, see people, not just their portfolios

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Hey, how are you doing? With the return of stock market volatility, an even better question is how are your clients doing?

It’s a simple question and one I’m certain was posed to countless clients in February. Probably more than ever, advisors appreciate and embrace their role as a behavioral coach—a role that encompasses not only portfolio management but also relationshipmanagement. Our new research clearly illustrates the importance of relationship management to clients and the imperative for advisors to adopt it.

Evolve beyond asset management

Our industry needs to continue to evolve beyond asset management as the sole basis for its value proposition. Yes, you can be an investment professional without being a professional investor. What’s the difference, you might ask? A professional investor might be defined as an advisor who believes that his or her clients are only concerned about their portfolios and, therefore, only contacts them about their portfolios. An investment professional sees the people, not just their portfolios.

This is an important distinction because holistic wealth management is most often broadly defined to include asset management, financial planning, tax and estate planning, insurance needs, and the like. The value of helping preserve and protect a client’s state of mind may be often overlooked, except by investment professionals.

Reinforce your value

So what can you do to allay your clients’ concerns and also reinforce the value of the relationship they have with you? Well, a “hey, how are you doing?” call is a great start. It shows them you think of them as a person and not just a portfolio. This is critical if you want to earn the highest degree of trust from your clients, since valuing clients, respecting them, and understanding their investment objectives and feelings are major contributors to clients’ trust. So what can you do to check all the boxes and, in the process, reinforce your value?

Try using our VALU framework for client conversations (see below). It may help them better understand your role in the relationship and your concerns for them as valued clients. In the end, you may not change anything in their portfolios, but hopefully you will have helped them better understand the advisor’s alpha you strive to provide.


Validate the financial plans you designed especially for them. While the headlines have changed, odds are clients’ objectives haven’t.


Assure them that uncertainty and volatility are normal. Let them know that you anticipated it, which is why you built their portfolio with an emphasis on asset allocation and diversification. These are the two most effective and widely available risk management tools, and you don’t have to pay more to benefit from them. Quite the bargain.

LLow cost

The cost-effective implementation of your portfolio strategy is one important way for you to potentially add value in the average client relationship. When investment returns are more modest than you expected over the longer run, the advantages of lower-cost and/or more tax-efficient funds and strategies become even more apparent.


Well, them. Remind your clients that successful investing often relies more on taming emotions than on taming the markets. In your partnership with clients, you excel at the role of the emotional circuit breaker who helps them when their emotions are in danger of overwhelming their reason. Emphasize to them that the reason they’re investing and the reason you’ve built their investment strategy is all about them—their goals and their aspirations.

Volatility highlights the need for behavioral coaching

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The most common topic of conversation I’ve been having with advisors recently is around market volatility. While the recent volatility is certainly normal in the context of long-term market behavior, it feels especially jarring with the memories of negative investment statements all but faded. Clients are feeling uneasy. Investor amnesia is real; we’ve all seen it!

If history has shown us anything, it’s that the stock market is destined to go through another sustained down period. Are you and your clients prepared for a potentially more challenging investment environment ahead?

The chart below offers an extreme example of the dangers of letting clients’ emotions control their investing decisions. Skittish investors who pulled their money from the markets during the 2008 recession missed out on the recovery. Investors who stayed the course were rewarded. That’s a lesson we can all learn when market volatility kicks in.

Investor discipline can have its rewards

Notes: Stocks represented by the Standard & Poor’s 500 Index. Bonds represented by the Bloomberg Barclays U.S. Aggregate Bond Index. Cash represented by the 3-month U.S. Treasury bill. The 50% stock/50% bond portfolio was rebalanced monthly. Data provided by FactSet. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Why behavioral coaching matters

In recent years your role as a behavioral coach has likely meant discouraging clients from taking on excessive equity risk or chasing higher yields. But being a successful behavioral coach also means helping clients understand the bigger picture of long-term averages and the need to stay in the markets during downturns.

You’ve laid the foundation to get them thinking long-term, to understand that markets don’t increase forever, and you’ve gotten them prepared for when the bulls leave and the bears show up.

There is a lot of talk around the value of advice, and in our advisor’s alpha research, we outline why we believe behavioral coaching can add significant value to your clients’ portfolios. Think of the example in the chart above. If you had successfully discouraged your clients from changing their 50% stock/50% bond portfolios to all cash in March 2009, then you would have saved them from missing out on 87% in returns.

Have a communication plan in place

Even if you’ve been talking to clients throughout your relationship about long-term investing, they’ll likely need to be reminded about those principles during the heat of a market correction. In a separate blog post, my colleague Don Bennyhoff talks about a VALU framework for client conversations where you reinforce the value you’re providing.

Here are a few of my own suggestions:

  • Prepare general talking points and have standard charts (like the one above) ready that you can use during times of market stress.
  • Talk to your staff about the messages you’ll be delivering to clients during tumultuous market events. They can help support your outreach and reinforce consistent communication.
  • Be proactive, and connect with clients before they contact you. Research shows that if you’re responsive and reach out to clients before they pick up the phone to call you, it goes a long way to building trust. Clients who had a high level of trust in their advisor have a 70% likelihood of giving them more money to invest and a 94% chance they would recommend their advisor to others.
  • And know what method of communication clients prefer. Some may need a simple email of reassurance, while others may require a phone conversation or an in-person chat. Try something different, such as a live webinar with your clients.

Putting clients on the right path

Successful investing and successful client relationships often rely more on taming emotions than on taming the markets.

In a world where advisors’ value propositions are under pressure, the better advisors will focus on areas where significant value can be added. We believe behavioral coaching is one of the keys to success.

Costs are an issue only in the absence of value

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Have you read the article where someone mentioned the importance of keeping investment costs low? Of course you have, and so have many other people. Research has shown that low costs are the most reliable predictor of higher returns. And it’s not just an indexing story. It’s just as true for actively managed funds. Judging by cash flows into the lowest-cost U.S. equity funds, that message has been received loud and clear (see chart below). Does that mean the cost of advice is next?

High-cost funds are under pressure
All U.S. equity funds and ETFs

Source: Vanguard calculations, using data from Morningstar, Inc.

Notes: Expense ratio quartiles were calculated annually. Shown for each quartile are the 2017 asset-weighted average expense ratios, determined by multiplying the annual expense ratios by the year-end assets under management and dividing by the aggregate assets in each quartile.
Before answering that question, I’d like to ask another: What’s the value of advice? This is arguably not only a different question but also the more important question, requiring a more effective answer than many advisors are prepared to offer.

Value is very subjective and often personal, and it relies on an assessment of both costs and benefits. It’s why we don’t all drive the same car or pay a CPA to do our taxes. It’s also why some people prefer to work with an advisor rather than try to handle their financial matters alone. Some people see the benefit, while others see mainly the cost. The tricky part is helping people see both links in the value chain, not only the cost but the benefit as well.

When a client works with you, the costs are generally transparent while the benefits are typically more opaque. That’s a tough combination, but it’s made easier if you understand our Vanguard Advisor’s Alpha® framework.

Crucial choices

There are choices you make—or don’t make—that can add value and help clients improve their investment outcomes, such as wise use of asset location, tax-efficient portfolio construction, and rebalancing (see chart below). These smart choices, however, are opaque to your clients unless you make them clear.

For example, if you have carefully built an investment portfolio with lower costs in mind, take the time to explain to clients how cost- or tax-efficient the portfolio or strategy can be. Investment management fees and taxes are an asset transfer—whether to a portfolio manager or a tax collector—and your clients’ wealth is usually better off when those transfers are kept to a minimum.

The value of doing nothing

Similarly, if you embrace a strategic rather than tactical philosophy, explain how that choice can benefit your clients. Too often, strategic is confused with being passive, when I’d argue it’s anything but. It’s actually an active choice to maximize the probability of cost and tax efficiencies while minimizing active risk. Sometimes the hardest but most beneficial thing you can do for clients is to help them do nothing. That specific choice would fall under the behavioral-coaching facet of advice, and, as our research suggests, being strategic by doing nothing can be a very significant value-add for an advisory relationship.

A menu of value-added services

Source: Francis M. Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, Yan Zilbering, and Donald G. Bennyhoff, 2016. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha. Valley Forge, Pa.: The Vanguard Group.

One last thing to consider: While you may already explain to clients what you do for them and why, do they know all you can do for them if the circumstances arise in the future? It’s highly unlikely that clients can benefit immediately from all you can do for them, particularly younger clients who may not yet need the wealth management services you might provide.

Giving all clients and prospects a menu of your value-added services can give them a better sense of the help you can provide, not only now but also later. Such comprehensive communication can aid in client retention and give clients a much better sense of your full value proposition over the life of their relationship with you.

While these are just a few examples to help you complete the cost-benefit value chain for clients, the most important idea may be this: If you want your clients to completely appreciate the value of the advice you provide, make sure the benefits of your advice are as clear to clients as the costs are.