Ethical investing with tax relief
You can get a diversified portfolio that matches your values and get tax relief.
Aadequate solution for the investor looking for a socially responsible portfolio: buy a fund.
Best solution for many people: buy a whole bunch of individual stocks.
In a taxable account, the portfolio of individual stocks has a big advantage over the fund. This creates opportunities for loss harvesting, i.e. the snatching up of underwater positions to generate capital loss deductions. Funds cannot compete with this. If the whole fund goes down, you can sell it at a loss, but the fund cannot selectively realize losses and pass them on to you.
Until recently, building a socially responsible portfolio out of individual stocks was quite impractical. This handicap is rapidly receding, thanks to fractional shares, $0 commissions and a proliferation of ESG data. You can filter acceptable stocks, place basket trades and maintain small positions.
“Technology has empowered individual investors to become sustainable investors,” says Michael Jantzi, founder of ESG ratings firm Sustainalytics.
At Fidelity Investments, you can filter out companies that MSCI ranks as “leaders” on a composite ESG score and that also cross other hurdles, like market capitalization. You can create a basket from successful tickers and then place a basket trade to buy 50 shares at a time, say $500 each. The fractional shares feature will come in handy if Shopify (recent close, $677) or BlackRock ($738) lands on your list.
Interactive Brokers, an online heavy-trading brokerage firm, can do all of this and more. In November, it introduced a sustainable investing platform called Impact that allows clients to get a personalized ESG view for any security that is sensitive to their particular concerns (the long list of criteria includes fossil fuels, marine life and animal testing).
You can use Impact to create a portfolio for basket trading or use it to score an existing portfolio, flagging actions that should give you pause. Impact has an interesting trade button that allows you to simultaneously sell an offending position and invest the proceeds in a similar company that has a better sustainability rating. Another Impact feature makes it easy to use highly valued positions for your charitable donations, yet another tax advantage for owning individual stocks.
Purpose in all of this, says Will Peterffy, ESG Director at Interactive Brokers (and son of Interactive’s founder): “Make your financial decisions align with your values.
Today, the homemade ESG portfolio is reserved for committed DIYers. It takes a lot of work to assemble a large inventory list, monitor it for potential crop losses, and place trades. It is likely, however, that the tools will become more accurate as brokers compete for the assets of both sustainability- and tax-sensitive investors.
If the process intimidates you, consider hiring a company to manage your portfolio. We’re talking here about what’s called direct indexing, the process of creating a collection of individual positions that mimic an index fund.
Direct indexing was once the plaything of the rich. They would send a few million dollars to a company like Parametric (now part of Morgan Stanley) or Aperio (now part of BlackRock) and get a semi-automated portfolio of several hundred stocks chosen to roughly track an index. scholarship. The minimums were high because in the old days positions had to be made up of whole shares.
Now the doors of this project are open to the masses. Wealthfront (soon to be part of Swiss bank UBS), one of the pioneers of robo-advising, offers a direct indexing option for accounts as small as $100,000. It enjoys the same tax benefits as large investors and clients can fine-tune their portfolios by excluding offending companies.
Fidelity Investments plans to soon offer a similar service called FidFolios. You can use it to get pre-screened actions on environmental and other criteria, and then, if you want, apply additional exclusions, ticker by ticker.
FidFolio’s minimum ante is only $5,000; the annual contribution 0.4%. Put one of these portfolios in a taxable account and chances are you can recoup the full management fee with tax savings, at least in the early years.
If the market continues to rise, you will find yourself, after a few years, with nothing but winning positions. At this point, the harvesting of losses is over, but the winners become excellent vehicles for charitable donations. Provided a position is more than a year old, the charitable deduction is calculated on the current market value, but the gain is never taxed.
Now here are some caveats about direct ESG indexing.
—Basket trades are only available for market orders. In a thinly traded stock, a market order is an invitation to get ripped off by the market maker. Stick to liquid stocks.
—Although commissions are free, bid/ask spreads are not. You will lose at least a penny per share in a round trip trade.
—You will encounter stumbling blocks massaging the action lists. While it’s easy to export a watchlist or an asset list to a spreadsheet, the reverse may not be. It seems that downloading tickers from a spreadsheet to a brokerage account is possible at Interactive but not at Fidelity.
Fidelity limits baskets to 50 stocks; Interactive no. Moving results from a stock screen into a basket is troublesome at Fidelity (tickers must be checked individually) but not at Interactive. In one respect, Fidelity makes life easier for DIY indexers: it allows export of ESG scores, unlike Interactive.
It might make sense for you to have two brokerage accounts. Use Fidelity to capture ESG scores as well as fundamental data. Use the resulting spreadsheet offline to create a shopping list. Then import that into Interactive and trade there.
—Due to index provider licensing rules, your broker may not allow you to copy an index (such as the S&P 500) to a file. Use a workaround. Create a similar index by looking at market capitalization and trading volume.
—The tax benefit associated with harvesting at a loss depends on your tax situation. Proponents of the strategy who predict a profit of up to 2% per year in the early years assume that part of the losses will be used to offset short-term gains taxed at high rates. But what tax-savvy investor is crazy enough to make short-term gains? You can deduct $3,000 per year of capital losses from your salary. But most of your losses may not occur until years later, when you offset the gain from the sale of a home.