Managed Money

Many people who entered the world of stock (equity) investing in recent years, mostly by choosing and buying stocks themselves or by buying shares in stock mutual funds, have profited handsomely by the decision to buy stocks. The long, strong bull market of the 1990s has produced historically high returns for most types of stocks, and attracted literally millions of new investors and billions of dollars into the marketplace. It has, indeed, been a real challenge for the reasonably diversified investor to lose money in recent years.

In 2001 and 2008, however, major corrections in the stock market occurred, introducing these investors to the unpleasant reality of extreme market volatility. Many portfolios that grew and compounded at double-digit rates for years had lost big percentages of their value, and even investors with long-term investment goals, who know that the only way to lock in a loss is to sell when the prices of their stocks or the net asset values of their mutual funds are down, are beginning to explore alternative ways to participate in the stock market.

An alternative route to stock investing that is regaining increased attention from affluent investors and their advisors is called an Individually Managed Account (IMA).

WHAT IS AN IMA?

An IMA is a portfolio of investments, in which the investor has direct ownership of each equity (stock) or bond in the portfolio, but delegates authority to make decisions about which securities to buy or sell to a professional money manager. An IMA, therefore, combines the beneficial features of investing directly in the stock market and investing through mutual funds, because the investor owns the stocks directly, but the expertise and research resources of a professional money manager are applied to the investment process and stock selection.

DISTINGUISHING CHARACTERISTICS

The important features of an IMA are:

  • the account is designed to conform to the investor`s individual investment requirements
  • the cost basis of each stock is set as of the date the security is purchased for the account
  • sell decisions can be orchestrated to minimize the individual`s tax liability

These are the defining characteristics of an IMA. They work together to produce some advantages that are important to investors, and that can have a positive effect on after-tax portfolio growth.

Individual ownership of stocks. Because you own the stocks directly, you can see exactly what companies you own and how many shares of each company. Your money manager can customize the portfolio to your investment requirements. You can also monitor your overall diversification, reducing the chance of inadvertently over- or under-diversifying your portfolio away from the appropriate level of risk for your investment strategy.

CUSTOMIZATION

There are many different `styles` of stock investing-some conservative, some moderate and some aggressive. When you select (with the assistance of a financial advisor) a money manager(s) who manages assets in the style appropriate for you, you have already customized your portfolio in terms of the types of stocks you will own. For example, a money manager who manages portfolios in the Large-Capitalization Value style will not buy new issues of companies with small market capitalizations.

In an IMA, you can further customize your portfolio, directing the money manager to seek out or avoid certain stocks or industries that meet or violate your personal standards.

COST BASIS CONTROL

When a stock is sold out of any type of investment funded with taxable dollars, there are tax implications. If the stock has appreciated, you must pay taxes on the difference between the price you paid for it (called the cost basis) and the price you sold it for. If the stock has declined in value, you can often use the difference between the purchase price and the sale price (the loss) to offset other investment gains, thus enhancing your after-tax return.

This makes it very valuable to you that, in an IMA, the cost basis of each stock is established on the date you buy the stock. Therefore, your portfolio benefits from 100% of any gain that occurs, and you can establish a basis for using 100% of any loss to offset other gains or other income. This benefit is only possible when you own the stocks directly.

TAX MINIMIZATION

In an IMA, you can decide when to sell each stock. This is important because of the tax laws that govern investment gains. If you hold a stock for more than 12 months, any gains you realize when you sell the stock are taxed as long-term capital gains, at 15%. If you sell the stock within 12 months of purchase, gains are considered to be short-term capital gains, and are taxed at your ordinary income tax rates.

If you are in the highest tax bracket, you can effectively halve your tax bill on gains if you hold investments for more than one year, and keep much more of each year`s returns on your portfolio. Because, in an IMA, you can control the timing of stock sales, you can protect more of your portfolio`s return each year, which will, over time,significantly enhance its growth. This type of control over portfolio returns is independent of market performance-no matter what the market does, you get to keep more of any gains your portfolio earns for you.

IMAS AND TAX-DEFERRED ASSETS

There are times when an IMA is also the appropriate choice for tax-deferred assets such as IRAs and 401 (k) plans. Although the tax-minimization characteristics of an IMA don`t apply to tax-deferred dollars, the benefits of customization are still important in that environment, enabling you to construct a portfolio that accurately reflects your investment preferences regarding style, risk management and other criteria.

COSTS

Another important consideration when choosing an investment vehicle is cost. If you decide that you want the benefits of professional money management, there are several effective ways to buy them. It is often difficult to calculate the costs of an investment accurately, but if you do, you will often find that the additional customization and control of an IMA is available at a lower total cost than other, less flexible investments.

CONCLUSION

As you consider your investment options, you may believe that an IMA is a good choice for some or all of your investable assets, but wonder whether your portfolio is large enough to qualify for this type of investment. As little as thirty years ago, Individually Managed Accounts were the prerogative of the extremely wealthy. Families with names like Rockefeller, Vanderbilt and Pitcairn founded banks and trust companies to manage the family assets. Institutional investors, like endowment funds, pension plans and foundations, hired professional money managers who required multi-million dollar investment minimums before they would undertake management of the account. But all that has changed.

Today, through innovative programs developed by forward-thinking investment advisory firms that have harnessed the power of information management technology, this flexible, efficient, customized method of investing is available at minimum investment levels as low as $100,000 per account, and at costs that are highly competitive with other investment alternatives. Today, many investors who have enjoyed the appreciation of the past bull markets, either in their taxable investments or in their qualified retirement investments, are in a position to access the further wealth-building capabilities of an Individually Managed Account. If you are one of these investors, KG can help you evaluate the benefits of such a choice for you.