The Taxable Investor's Manifesto. Stuart E. Lucas

also wish to thank my editor, Bill Falloon, and Wiley, my publisher. They have been great partners and supporters of this project, providers of constructive feedback, and they moved expeditiously to bring this book to life.

      Lastly, thank you to my family. My father and my late mother raised me right and helped me to flourish. My siblings and their spouses, especially Boutie and Melissa Lucas, are willing collaborators in our family enterprise. Some are engaged every day; the others hold us accountable in thoughtful, constructive ways. My children, nieces, and nephews are making their own way in the world, developing their own careers, and making their parents proud. This book would not exist without them being the people they are.

      The best decision I ever made was to ask Susan to marry me thirty years ago. We are only just getting started. In addition to being the love of my life and my partner raising our three wonderful children, she has also been my business partner for ten years. A compassionate wonderful human being, she is also a highly gifted leader and businessperson. She supports me emotionally; she is a fantastic thought partner and an excellent editor. Her hands are all over this book. I truly am the luckiest guy in the world.

Introduction

      This is not a book about tax; it's about fomenting a quiet revolution. The Taxable Investor's Manifesto is your guide to maximizing profit from your financial assets over a lifetime and beyond. It's also a book about how to compete side by side against the majority of investors who don't pay tax. And it's about the skilled advisors who will help you manage your hard-earned wealth most effectively.

      Taxable investors need to think differently. It's my experience; it's my mantra. It's the truth. And yet, try to find comprehensive guidance about personal finance that makes a serious stab at optimizing the combined effects of the money we earn, our investments, and the taxes we pay. It's darn near impossible, and I know where to look. I have spent 35 years in the investment and wealth management industries and received thorough academic and professional training.

The bottom line is that almost everyone who studies finance academically or advises us about our personal finances treats taxes as an afterthought, at best. It's very difficult for academics to access the diffuse data they would need to study our after-tax investment returns, so they don't. As a result, financial advisors haven't received sufficient training to optimize the returns to their taxable clients. In addition, the metrics that academia and the financial industry have developed to assess performance are designed without consideration of tax impact. When proper metrics don't exist, firms don't have the tools to monitor and incentivize their advisors to reduce our tax bill, and we have a hard time understanding what we are missing. These omissions are all rational given the current circumstances. But they come at a large cost. If academics, advisors, training program designers, and taxable clients all pull together, we can change the wealth management industry for the better.

      Why should we care? For starters, the right advice is worth a great deal of money; to the tune of $5 million on an initial $1 million investment. That's good for clients and it's good for the fee base on which advisors earn their living. Let me explain. Unbeknown to me, a sophisticated investor who read a draft of this manifesto modeled the likely after-tax profit over 30 years on a $1 million initial investment under two scenarios. First, he modeled his existing portfolio of cash, fixed income, hedge funds, and actively managed equities. Roughly 60% of the portfolio was in equities. Second, he modeled a portfolio using the manifesto's strategy. With the same assumptions for market returns and for tax rates, using his current strategy the portfolio grew to about $4 million over 30 years; using the manifesto's strategy, $9 million, after tax. I was shocked by the difference. I knew it would be big, but until then I hadn't done the math. So I hired an analyst to build his own model. The answer was similar. A $5 million difference; that's why investors should care and that's why their advisors should care. Their interests are aligned to maximize after-tax returns. By the way, whether you start with $100,000 or $10 million, or even a billion dollars, the benefits are proportional. Is that potential impact worth a few hours of your time? Make your own assumptions. Do your own math. You will see the difference.

What are the underlying sources of that huge difference, and why is the difference so much larger than if a tax-exempt investor employed the same model? Shifting to a more equity-heavy portfolio benefits both types of investor, because over the long run equities have outperformed bonds, cash, and most hedge funds. But for the taxable investor the impact is much more profound. Because of the nature of our tax system, most of the profits on fixed income and hedge funds are taxed each year, and they are taxed at higher rates. Managing equities in a tax-efficient way enables investors to defer the payment of taxes for years and years, sometimes decades. A properly structured investment portfolio reduces tax drag and dramatically increases the power of compounding. The combination of equities, time, tax efficiency, and compounding can be worth millions.

      Let me be clear. I firmly believe that it is the civic duty of every successful American to pay taxes; it's a responsibility and a privilege. Cognizant of the many benefits of living, working, and raising a family here, I am happy to pay my share. This manifesto simply advises that taxable investors should develop investment strategies with the tax and estate planning implications rigorously embedded in their design and management process. Doing so is common sense, if not commonly employed. Plus, it reinforces a healthy long-term perspective, a business-owning mindset, and, with a vibrant economy, a larger tax base.

      For those of us who are trying to save for retirement and accumulate additional wealth through our careers, through employment income or by starting and growing businesses, the difference in asset accumulation, financial security, and lifestyle between average wealth management and good wealth management is huge. The manifesto's strategy becomes even more compelling when an investor is managing wealth multigenerationally. It is also a guide for navigating over much longer time frames and through a maze of estate and gift tax laws.

      The quest to understand and manage taxable wealth is personal for me. My great-grandfather started the Carnation Company in 1899. After 86 years the company was sold and we shifted from being a business-owning family to a “financial family.” I've been lucky: lucky to be born into wealth, lucky to get a great education, lucky to get superb training as a professional investor, lucky to teach. All these experiences, all the learning, are crystalized in this manifesto. My goal in writing it and sharing it is to change the world in one small way: together, with common knowledge and resonant voices we can find a better way to manage taxable financial assets, secure financial futures, and provide higher-quality advice.

My previous book, Wealth: Grow It and Protect It, was published in 2006. Its goal is to help wealth owners to manage their wealth strategically and comprehensively across business, financial, and cultural dimensions. It all starts from establishing a purpose for their wealth, based on their core values. More than twelve years and a second edition later, the book is still in print. People are still buying it, reading it, implementing it, thanking me for writing it, and coming to me for further advice. With some frequency, readers show me their copy with 30 separate pages or more dog-eared and highlighted. It's incredibly gratifying to be able to help people in this way. Hopefully, The Taxable Investor's Manifesto will have similar impact and similar longevity.

      In Wealth, I offer eight principles of wealth management. The very first one is: Take Charge. Over the last 35 years as the wealth strategist on behalf of my clients – including my family – and myself, I've learned that no one is in better position to optimize your wealth than you.

      In writing The Taxable Investor's Manifesto, I've drawn from a lot of sources: from the wisdom of others, from experience gained from making mistakes with my own money, and from careful analysis across investing, tax, and estate planning disciplines to figure out how to do it better. What I've learned applies to every taxable investor, regardless of how much wealth he or she has been fortunate to accumulate. After reading and studying you will understand why taxable investors and their advisors need to think and act differently, and you will learn how to do so. Integrating the combined effects of investing, tax management, and estate planning is good financial management and good business. Good financial management