The decision to invest in a new portfolio typically follows thoughtful consideration around choosing the appropriate strategy and manager. However, the process of actually moving assets from an existing portfolio to a new one can be challenging. While transitioning assets to a new portfolio can be a complex, manual and extremely time-consuming process, if not handled with care, investors may be hit with significant tax consequences and exposed to more market risk than they want.

The good news is that tax-managed portfolio transitions are now significantly easier to achieve. J.P. Morgan’s intelligent tax technology is a digital solution can help advisors optimize the potential tax consequences when transitioning a client’s portfolio. By providing a spectrum of options, our intelligent tax technology helps investors make informed decisions about taxes and market risks that consider their personal preferences. Most importantly, investors also benefit from an efficient transition process that may deliver significant tax savings.

Common portfolio transition scenarios

Portfolio transitions are almost always necessary when changing advisors, but they can occur for many common reasons: changing investment strategies at different stages of life, funding a new account for a family member from your own account, transferring inherited assets into your own portfolio or diversifying concentrated stock positions, such as company stock awards.

Investors normally take time to consider changing investment advisors or strategies, finding one that suits their financial needs and risk management preferences—because they know that rushing into a change could be costly. That careful consideration should follow through to the portfolio transition for the same reason, because a poorly managed transition can potentially result in several negative outcomes: a higher capital gains tax bill than necessary, taking on unintended market risk and portfolio underperformance.

Taxes and market risk management is key

In a transition, holdings of an existing portfolio will often be transferred “in kind” to the new portfolio and those that fit into the new strategy will remain. However, some portion of assets may ultimately need to be sold—and the proceeds invested in new positions—to bring the portfolio in line with the new investment strategy.

Many investors are wary of transitioning portfolios because they know selling many holdings at once could trigger significant realized capital gains and a big tax bill. At the same time, they may equally dread selling assets at a loss. However, realizing losses in select holdings can help offset gains—a strategy called tax-loss harvesting—and reduce the total tax bill resulting from the transition.

Transitions must also balance near-term tax consequences with medium- and longer-term market and performance risks. For example, if concerns about taxes cause investors to delay selling holdings and reinvesting the proceeds, the portfolio may take on extra risk from having too much or too little exposure to certain securities or parts of the market.

Completing the transition can be done over time, based on a client's objectives and tax situation. The careful customization of a transition could also help balance market and performance risk over that time.

How a tax-smart transition works

To understand how a tax-managed transition works, it's helpful to consider two key concepts:

• Tax budget: the target amount of estimated taxes an investor would be willing to pay to transition all or some of the legacy holdings to the target portfolio. The tax budget is then used as an input to determine how much of the legacy portfolio can be transitioned to the target portfolio.
• Tracking error: the amount that an investor’s portfolio holdings deviate from the target portfolio allocation. When new portfolios are not completely aligned with their targeted holdings and weightings, their returns over time may differ, which is a risk investors must consider. 

Investors willing to pay a higher tax bill should be able to transition a greater portion of their holdings to the new portfolio, resulting in lower tracking error. Importantly, a tax-managed transition is not an all-or-nothing process, and it can be adjusted to take weeks, months or years to complete, depending on how much of the legacy portfolio matches the target portfolio, market volatility and an investor’s preference for minimizing taxes or tracking error.

Our Tax-Smart Platform can help

A tax managed transition may reduce many of the negative outcomes and risks associated with transitioning to a new a portfolio. However, the process has historically required a significant amount of manual work and time from advisors, and errors can be costly.

J.P. Morgan Asset Management’s intelligent tax technology can help advisors and investors plan a customized transition and offers ongoing tax analysis and effortless tax-loss harvesting—with no daily management or manual monitoring required. An advisor using the Tax-Smart Platform can match up gains and losses across hundreds of different tax lots in an investor’s portfolio in just a few seconds—a process that can otherwise cost hours of manual work.

An intelligent tax transition seeks to balance the tradeoff between the size of the tax bill and how closely the post-transition portfolio matches the target portfolio, and then provides investors with a range of choices to consider. Investors and their advisors can review the options together to plan an efficient transition tailored to an investor’s preferences.

It’s important for investors to understand that tax management can play a major role in maximizing potential portfolio returns. When choosing an appropriate asset allocation and investment strategy, consider adding tax-management strategies to the discussion. And, while tax management has historically been costly in terms of time, potential errors or unintended changes in the portfolio’s exposure, our intelligent tax technology can help investors save on taxes and maintain portfolio construction, while saving you time.