How to Impress Your Largest Clients and Unlock Liquidity
Financial advisors have a tough job, as they are required to wear many different hats on a daily basis. Advisors are asset allocators, market analysts, sales prospectors, and sometimes are required to act as a client’s psychologist when things become turbulent in financial markets. Their job is to maintain and service their current client base while simultaneously seeking out new clients and funds for investment. As a result, their schedules are often very busy, leaving little time to seek alternative ways to generate alpha for their clients.
The holy grail for advisors is having a book of large clients who are eager to refer their colleagues and friends. However, this is not something that’s easily achieved. High-net-worth individuals are oftentimes the most market savvy, require the most attention, and have been approached by numerous advisors in the past. As a result, a financial advisor must do something to stand out from the crowd in order to attract and retain these clients.
Most wealthy people have significant tax liabilities, and it’s no secret that they hate paying taxes. Their fortunes have grown over time, and with that comes the requirement to give Uncle Sam his cut whenever a profit is realized. Because of this, many just choose to defer a sale and hold onto whatever assets are in their portfolio. This can be a big mistake, and many investors and advisors make it. Clients with large, concentrated positions tend to amass their wealth by (1) working at the company that provided them equity, (2) inheriting a position or (3) taking a sizeable, concentrated position that worked out…. for now. Numerous studies have shown that portfolios with concentrated positions will eventually underperform the market – it’s only a matter of time. 1Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. ”The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189 2Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf 3Bernt Arne Ødegard, “The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?” Finance Research Letters Volume 6, Issue 2. https://doi.org/10.1016/j.frl.2009.01.003 Holding a concentrated portfolio generally increases volatility, adds to biases, and leaves little cash available for new investments. It also makes properly managing a portfolio difficult and time consuming.
The good news is that there are tools that provide solutions to these common problems experienced by high-net-worth individuals. Options are often (and rightly) viewed in a negative light among retail investors, as they can be very risky and lead to substantial losses. Options are complex and can be intimidating to even the most seasoned investor. What many people don’t realize, though, is that options can also be powerful tools for tax optimization and hedging within a portfolio. When correctly implemented, an option overlay strategy may completely eliminate tax liability on certain concentrated positions, while simultaneously hedging downside risk. Imagine telling a client with hundreds of thousands, if not millions of dollars of embedded gains that you have a panacea for their concentrated position woes, and you can help them rebalance the position without having to pay much or any capital gains taxes. Offering a little-known tax optimization strategy can serve as a means of differentiation for an advisor, providing material future potential growth opportunities such as referrals for their business. These strategies can potentially unlock liquidity, reduce portfolio volatility, enhance returns, and further opportunities for the people who are most likely your wealthiest clients.
If you currently have clients in this position or would like to learn more about tax-optimization strategies that can help grow your business, contact us for a consultation.
This blog post is for informational or educational purposes only and is not intended as investment advice. Any discussion of investment strategy or approach is intended only to illustrate investment concepts and in no case does the discussion represent Exceed Advisory’s investment performance or the results of any Exceed Advisory portfolio. We provide investment advice only to clients and only after entering into an advisory agreement and obtaining information concerning individual needs and objectives. We think the information provided is accurate, but accuracy is not guaranteed. All investing in securities involves risks, including the risk of loss.
