Should you let tax policy dictate your investment strategy?

Rapid and repeated trading not only increases risk and volatility in a portfolio, but also triggers tax consequences.

August 15, 2017 | Insight

The federal government recently announced proposed changes to the tax rules for private corporations. While the changes were not unexpected, the extent of them was. These amendments, if implemented as announced, will have a significant impact on many people’s small businesses and family estate plans. As investment professionals, we are looking at how these proposals will affect the financial planning we do for our clients, as well as the planning we do for our own family business.

With the proposed tax revisions, having a consistent investment strategy becomes even more important since the proposals are intended to eliminate the benefit of using after-tax corporate dollars to invest. This means the need for efficient returns is increased.

At Genova, our investment strategy has always been to buy good companies at a good price with the intention of owning those companies for a long time. This allows the success of the portfolio to be driven by the success of the underlying businesses, rather than either the short-term swings in stock market sentiment or the ever-changing tax rules. This approach remains solid even under the proposed tax amendments, although how an investment is held (holding company, operating company, trust or personally) may change.

Remember that for investments made through taxable accounts, tax is only paid when: 1) a gain is realized because you sold an asset for more than you paid; or 2) you receive income in the form of dividends or interest.

If an investment has long-term growth potential, a sustainable competitive advantage, and can be bought at a good price, then holding it for a long time is a great tax deferral strategy. This should make sense to many small business owners including incorporated professionals. They invested in themselves and reinvested earnings at a high rate of return in their operations to create wealth for the long term. By investing in companies that can produce growth most years, the investor will benefit from that growth on a tax deferred basis. Rapid and repeated trading not only increases risk and volatility in a portfolio, but also triggers tax consequences that will have a negative impact on wealth creation.

As final legislation has not yet been released, the longer-term effect of the tax proposals on asset planning and succession planning is still to be determined. We will, however, help our clients navigate the new environment. Creating wealth from the long-term ownership of good businesses remains one of the best investment strategies available. While the proposed tax changes will be felt by many, always remember that if you must pay tax, even at a high rate, it means you are making money.

We certainly would take that over the alternative.