For investors with portfolios exceeding $1 million in investible assets, tax drag often becomes the single greatest hurdle to long-term wealth compounding. As assets accumulate in taxable brokerage accounts, the "leakage" to Uncle Sam can significantly erode your real rate of return.
Simply put, tax drag is the reduction in investment returns caused by income taxes. When a portfolio generates interest, dividends, or capital gains in a taxable account, a portion of those gains is siphoned off to pay the IRS instead of remaining invested to benefit from compounding. Over a decade, a 1% to 2% annual tax drag can cost a multi-million-dollar portfolio hundreds of thousands in lost growth.
For high-net-worth investors, tax efficiency must move from a year-end afterthought to a proactive, year-round goal of portfolio management strategy. All high-net-worth taxpayers should consider the following six advanced strategies to optimize their portfolios in a tax-efficient manner:
Strategic Asset Location
Not all accounts are created equal. Asset location optimization means placing specific investments into the specific account type — taxable, tax-deferred, or tax-exempt — that provides the greatest tax advantage for a given asset class.
- Tax-inefficient assets: High-yield bonds, real estate investment trusts (REITs), and actively managed funds that trigger frequent distributions generally belong in tax-advantaged accounts like a traditional IRA, SEP IRA, or 401(k).
- Tax-efficient assets: Long-term growth stocks, index funds, and municipal bonds are better suited for taxable brokerage accounts.
For investors with portfolios exceeding $1 million in value, coordination is key. Without a tax-holistic view, an investor may accidentally hold assets in the incorrect account type, triggering avoidable tax bills and/or "wasting" tax-sheltered space.
Sophisticated Tax-Loss Harvesting
Tax-loss harvesting means selling underperforming assets at a loss to offset capital gains to lower your overall tax liability.
For high-net-worth individuals, tax-loss harvesting is more complex. To maximize this strategy:
- Avoid wash sale triggers: The IRS disallows the loss if a taxpayer buys a "substantially identical" security within 30 days before or after the sale.
- Coordinate accounts: Dividend reinvestments or trades in a spouse’s account —or even in tax-deferred accounts — can accidentally trigger a wash sale and cancel out the tax benefit you were trying to capture.
A coordinated loss-harvesting strategy can save a taxpayer from a wash sale while saving money.
Direct Indexing
While most investors use exchange-traded funds (ETFs), high-net-worth families often pivot to direct indexing. With direct indexing, instead of buying one fund, a taxpayer owns the individual underlying stocks.
This gives you more control. For example, even if the S&P 500 is up overall, some of the individual stocks in it may still be down. That creates opportunities to sell those losing positions for tax purposes while still keeping the rest of your portfolio invested.
This can work especially well for people with large taxable accounts or concentrated stock positions, but it does take active management to keep the portfolio aligned and avoid selling positions you may be better off holding. Working with advisors can help with this.
Optimized Holding Periods
The difference between a "short-term gain" and a "long-term gain" is, for many high-net-worth taxpayers, the difference between paying tax at a ~40.8% tax rate and a ~23.8% tax rate.
Before rebalancing or trimming a position, a taxpayer should review holding periods. Waiting even a few days to cross the 12-month threshold can give you significant tax savings.
Advanced Philanthropic Strategies
Charitable giving can be a smart way to reduce capital gains taxes while also supporting the causes that matter most to you.
- Donate appreciated securities: Avoid capital gains tax entirely by gifting long-term appreciated stock directly to a charity; there is the potential to get a deduction for the full fair-market-value of the donated stock (subject to income and other limits).
- Donor-Advised Funds (DAFs): "Bunch" several years of donations into one high-income year to exceed the standard deduction and maximize tax efficiency. This strategy can be executed in conjunction with donations of appreciated securities.
- Qualified Charitable Distributions (QCDs): If you’re required to take money out of your IRA, you may be able to send some or all of it directly to a charity instead. That can count toward your required minimum distribution without increasing your taxable income.
Roth Conversions
A Roth conversion allows taxpayers to move pre-tax IRA funds into tax-free Roth accounts. While tax is paid upfront, upon conversion from traditional to Roth accounts, the assets grow and can potentially be withdrawn tax-free in future years. This move is particularly effective in low-income years. It gives you a "hedge" against future tax hikes and gives the flexibility to pull from different buckets in retirement to stay within a specific tax bracket or leave income tax-free funds to any heirs.
Building a Proactive Framework
For advisory help with your family office or individual goals, Mowery & Schoenfeld combines investment management with integrated tax planning for high‑net‑worth individuals and families. Talk to an advisor about coordinating your tax plans with your investment strategy.