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As someone with a high-net-worth, you have a few specific considerations to consider regarding your investments.
The basic principles still apply—having a plan, diversification, fee management, and taxes—but you need to think beyond standard investment advice.
You can use our free spreadsheet to help you see the different limits and tax rates that may impact you.
Here are a few high-net-worth investment strategies to keep on your radar.
Traditional Portfolio Management
The foundation of your investment plan should be a well-balanced portfolio that considers your goals, risk tolerance, and time horizon.
Exchange traded funds, also known as ETFs, make it easy for you to build a scalable and manageable portfolio. This is particularly important as you near or enter retirement. In particular, as a high net worth investor, you may consider focusing on ETFs rather than mutual funds because they are generally:
Tax-efficient
Low cost
You’ll typically also may have fewer “surprise” fees with ETFs.
Broadly diversified
Keep in mind that your investment portfolio will comprise a wide range of securities that fit your goals, time horizon, risk preferences, and more.
As a financial firm specializing in high-net-worth clients, we can help you tailor your investment strategy to help you build wealth sustainably over the long term.
Tax Planning
Alongside portfolio construction and management, one of the most significant distinguishing characteristics of high net worth investment strategies is the importance of directly incorporating tax management into the investment plan rather than addressing it separately.
Many high-net-worth individuals make the mistake of making investment decisions without taking into account their total tax picture. Investing without tax management can create huge tax mistakes and reduce your wealth over time.
While taxes don’t have to be in the driver's seat at all times, they should be a central consideration as you select and manage your investments. Tax considerations can also help drive the selection of different types of accounts that you'll invest in throughout your life.
Let’s take a look at some of the most common.
Account Types
Workplace Qualified Retirement Plan
If you have access to an employer-sponsored retirement plan like a 401(k), that should be your first stop. Take full advantage of the annual contribution limits to your retirement accounts (Don’t forget the catch-up if you’re 50 or older). If you can choose Roth contributions, that's something worth exploring. Unlike a Roth IRA, Roth 401k contributions don’t phase out because of your income.
Also, consider whether making after-tax contributions up to the annual additions makes sense for you. Doing so may allow you to move a significant amount of money into a Roth account by making mega backdoor Roth contributions.
Mega backdoor Roth contributions can be a powerful strategy for high income earners who earn in excess of $214,000 for married filers and $144,000 for single filers.
Taxable Brokerage Accounts
Many high-net-worth individuals have a significant amount of savings outside of tax-advantaged accounts. You should have a deliberate plan for addressing taxes when investing in a brokerage account.
Here are some things to consider:
Leverage long-term capital gains when possible. Long-term capital gains are generally taxed at more favorable rates than regular income, but you’ll need to hang onto your investments for at least a year to be eligible.
Strategically realize capital gains. You pay taxes in your brokerage account when you sell your investments. Perhaps you’ll realize some gains in an otherwise low-income year or a year where you plan to make significant charitable contributions.
Employ tax-loss harvesting. Not all of your investments will earn money all the time. So if you have an asset that’s losing money, you could capitalize on it and claim it as a capital loss. You can use tax-loss harvesting to offset higher gains and use up to $3,000 in losses to reduce ordinary income. When tax-loss harvesting, be mindful of the wash-sale rule. The wash-sale rule keeps investors from selling and buying identical or similar investments within 30 days of the sale. What a lot of people don’t know is that the wash rule can be triggered if you sell a stock in one account and repurchase it within thirty days in another account. Be careful!
At Covenant Wealth Advisors, we often analyze the impact of realizing long-term capital gains and implementing tax-loss harvesting strategies by reviewing your tax return as well. We suggest that you do the same.
Asset Location
Consider the tax differences between your various account types when choosing where to hold your investments. In general, try to hold:
Your most tax-efficient investments in taxable accounts (tax-free bonds, stocks held long term)
High growth investments in Roth accounts over tax-deferred accounts (stocks)
Investments that make regular distributions in tax-deferred accounts (bonds)
For the investments in taxable accounts, take full advantage of tax-loss harvesting. Recognized losses can offset realized gains on a dollar-for-dollar basis and significantly increase the after-tax return of your portfolio.
Implementing the appropriate asset location for your investment portfolio has the potential to:
Improve your after-tax returns
Transfer more wealth to your heirs
Reduce taxation of your assets in retirement
Investments
You may be able to increase the tax efficiency of your taxable investments by:
Investing in assets that have little turnover (won’t generate as many internal taxable gains to be distributed to you)
Leaning toward capital gains rather than taxable cash flow (interest and dividend payments)
Waiting to realize gains once they become long-term
Holding asset classes like individual stocks or passive ETFs for the long-term may help reduce your taxes by reducing turnover.
And don't make the mistake of chasing yield on investments for the sake of creating the optical illusion of greater returns. We see this all of the time and it can be a big mistake.
Unless you actually need the additional income in the first place, most investors may want to pursue greater returns through a total return strategy. A total return strategy seeks to improve total returns by combining capital gains plus dividends and interest. In an ideal world, high-net-worth investors should want all growth coming from capital gains due to the improved tax efficiency and power of compounding returns.
Direct Indexing
Direct indexing is a more modern high net worth investment strategy you may want to consider if you want to reduce taxes or if you have highly concentrated stock positions.
We are big fans of utilizing index funds for the reasons we outlined above. Direct indexing is similar to investing in index funds. However, it has the added advantage of giving you more control over your particular tax situation.
Instead of using ETFs to fulfill your asset allocation, direct indexing takes the approach of buying each individual stock separately. Using this approach allows you to take advantage of potential tax-loss harvesting opportunities at the security level that would otherwise get washed out if you held the index via an ETF.
Another potential advantage of direct indexing is to help diversify out of highly concentrated stock positions.
For example, let’s assume that you own $100,000 of Amazon stock and your total portfolio is $3 million. In this scenario, Amazon already represents over 6% of your portfolio value. As a result, you may not want to own more Amazon in other holdings such as ETFs or mutual funds.
So, what do you do?
With a direct indexing approach, your advisor can build an index that excludes Amazon stock to avoid duplicating your current ownership of Amazon. This helps avoid owning more of the stock and better positions you to sell out of the stock over time to build a more diversified portfolio.
While not guaranteed, proper diversification may help temper the volatility of your holdings.
Municipal Bonds
The interest you receive from municipal bonds may be tax-free at both the state and federal levels, making them especially attractive if your state has an income tax.
Although tax-free bonds often pay lower interest rates than similar taxable bonds, you may end up with more money in your pocket with a municipal bond.
Here is an example of how municipal bonds can benefit high-net-worth and high income investors:
John owns a taxable corporate bond that pays 4% interest. He is in the 37% tax federal tax bracket. After taxes, he only earns 2.52%.
Martha owns a tax free municipal bond that pays 3% interest. She is also in the 37% tax bracket. However, because the bond pays tax free interest, Martha's net return is still 3%.
Martha's return is .48% better than John's return.
What's the point? Don’t compare the interest rates of municipal bonds with corporate bonds without accounting for your personal tax situation.
Invest To Protect Against Inflation
Inflation is likely to play a major role in all areas of our finances, and investments are no exception. You should think about how inflation may impact your financial goals and how you can invest to protect against inflation up to and through retirement.
The stocks in your portfolio can serve as a great long-term hedge against inflation. While never guaranteed, the stock market has historically provided a return that exceeds the rate of inflation (called real return).
Some fixed-income investments address inflation directly. Those include:
Treasury Inflation-protected securities. These bonds pay a fixed interest rate, but the bond's principal amount is adjusted every six months to reflect changes in the consumer price index. The dollar amount of interest you receive is based on the interest rate and the new principal amount.
I Bonds are another treasury bond type with a built-in inflation adjustment. Instead of a principal adjustment, the interest rate on these bonds will increase when inflation rises.
Bonds also offer investors liquidity, which frees them up to make major purchases, cover planned higher tax bills, and improve cash flow.
In addition to bonds, real estate and value stocks have historically proven to be a strong hedge against inflation.
Here’s more on how to protect your portfolio against inflation.
A High Net Worth Investment Plan Tailored To You
As a high-net-worth investor, we’ve walked through a number of ways to enhance your investment portfolio and position yourself to better reach your goals.
Contribution limits, deductibility, and tax rates become a much more significant consideration when you reach certain asset and income levels.
Many of these strategies require sophisticated financial planning.
So, to build a strategy that’s right for you, it’s often beneficial to work with a financial advisor. We would be glad to help you figure out the best high-net-worth investment strategies to help you reach your financial goals.
Schedule an appointment with our wealth management firm today.
About Mark Fonville, CFP®
Mark is a personal financial advisor and the President of Covenant Wealth Advisors. He provides retirement income planning for individuals age 50 plus who have over $1 million in investments.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place.
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