- Why Dimensional
Dimensional Fund Advisors offers separately managed accounts that meet the needs of taxable entities and individual investors. The goal in separate accounts is to increase after-tax returns for given risk exposures. This is a long-term objective. Focused portfolio design, tax management, broad diversification, low trading costs, and low management fees achieve it.
The client faces a complex set of trade-offs. Analytical tools assist in setting the balance among the client''s attitude toward risk and return, preference for capital gains and dividends, and need for diversification. Each separate account is customized according to the client''s objectives, risk tolerances, and tax circumstances. It manages scheduling and amounts of capital gains or losses and the dividend stream.
What we know about the dimensions of returns assists in portfolio design, while our tested tax-management techniques and efficient trading methodology can help increase after-tax returns. Tax-managed separate accounts afford investors opportunities to build customized, diversified portfolios structured to their specific objectives:
Dimensional''s goal is to increase long-term after-tax returns. This requires analyzing and prioritizing decisions specific to tax management, namely rebalancing and the realization of capital gains and losses.
|MUTUAL FUNDS||SEPARATE ACCOUNTS|
|Timing of capital
gains and losses
|Determined by portfolio manager.||Determined by investor or advisor.|
|Capital gains legacy||Investor may face tax liability for capital gains distributions while experiencing loss on
total fund investment.
|Capital gains determined
by investor''s cost basis.
|Charitable gifting||Investor cannot control disposition of specific stocks.||Investor can donate highly appreciated securities.|
|Diversifying low-cost positions||Offer the quickest way
to achieve broad diversification.
|Reduce tax liability from unwinding low-cost-basis position by harvesting losses over time in rest of portfolio.|
|Investment breadth||Access to broad set of asset classes.||Account size and transaction cost determine investment breadth.|
|Net realized capital losses||No pass-through; can only be carried forward.||Deductible in year realized; can offset other income.|
in computing net investment income.
|Only expenses exceeding 2% of AGI are deductible. No deductibility under Alternative Minimum Tax.|
Rebalancing adjusts a managed portfolio''s holdings in order to more closely match the risk/return characteristics of a client''s target portfolio. Dimensional usually rebalances the domestic equity portion of each separate account at thirty-one-day intervals.1 Because of higher trading costs, international holdings are rebalanced less frequently.
Some rebalancing is accomplished without tax consequences. For instance, new contributions of cash permit purchases that do not need to be funded by sales. Coordinated management of the client''s tax-deferred and taxable accounts can also create tax-free rebalancing opportunities if trades producing gains can be confined to the tax-deferred account. Charitable contributions of appreciated securities can also create tax-free rebalancing. Carefully planned redemptions facilitate rebalancing and tax management.
Rebalancing often requires selling assets that have appreciated, which can result in realized capital gains. Effective management of capital gains is essential for increasing after-tax rates of return.
The objective of tax management is to control the timing and amounts of tax liabilities for the purpose of increasing after-tax returns. Taxes that can be deferred are deferred, and taxes that can be avoided are avoided. Some capital gains must be realized when most new accounts are opened and in subsequent rebalancing. Capital losses can offset some or all of these gains.
At any time, a broadly diversified portfolio contains unrealized losses. Whenever the tax savings of a potential loss are sufficiently greater than trading costs, the loss is recognized. Realized losses are inventoried to offset realized gains in the current or other applicable tax years.
The ability to generate a supply of capital losses is another advantage of diversification. In concentrated portfolios, few capital losses may be available for harvesting. This can make the tax costs of portfolio adjustments prohibitive and cause an investor to remain locked into a few stocks with large unrealized gains.
Realized losses within an account can be used to offset realized gains outside the account. Tax efficiency increases when Dimensional coordinates management of the account with any gains and losses outside the account.
Tax-lot accounting manages capital-gains taxes. When a particular stock is purchased in multiple lots at different prices, each lot has its own cost basis. Whenever holdings are sold, the shares with the highest cost basis are sold first. This minimizes gains and maximizes losses, so tax liabilities are reduced.
Trading costs erode returns and hinder the accumulation of wealth. Once a managed portfolio is in place, discretionary trades are carefully made only to rebalance and harvest capital losses.