Tax-aware asset allocation

• US 8,200,561 B1
• Filed: 03/31/2003
• Issued: 06/12/2012
• Est. Priority Date: 03/29/2002
• Status: Active Grant

• Current Assignee: Edelman Financial Engines LLC
• Original Assignee: Financial Engines Incorporated (Edelman Financial Engines LLC)
• Inventors: Watson, John G., Hu, Wei-Yin, Scott, Jason, Schwab, Joshua David, Shearer, James William
• Primary Examiner(s): Hammond, III, Thomas M
• Application Number:
  US10/404,818
• Time in Patent Office: 3,361 Days
• Field of Search: 705 35- 40
• US Class Current: 705/36.T
• CPC Class Codes: G06Q 40/06 Asset management; Financial planning or analysis
• CPC Class Codes: G06Q 40/10 Tax strategies

Abstract

A method of tax-aware asset allocation is provided. According to one embodiment, information is received regarding financial products available for investment in a taxable account and a tax deferred account of an investor. Information is also received regarding current investments held in the taxable account and the tax deferred account. Tax characteristics associated with each financial product is determined by evaluating information regarding distributions and/or information regarding turnover. Relevant financial circumstances of the investor are also determined. Finally, advice is formulated regarding a recommended portfolio of financial products, including a recommendation regarding which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held by performing a portfolio optimization process that takes into consideration the tax characteristics, the relevant financial circumstances, and tax implications of holding the financial products in the taxable account versus the tax deferred account.

Claims

1. A method comprising:

one or more processors of one or more computer systems receiving information regarding each financial product of a set of one or more financial products available for investment in a plurality of accounts of an investor having different tax treatment, the plurality of accounts including a taxable account and a tax deferred account;

the one or more processors receiving information regarding current investments held in the taxable account and the tax deferred account, including information regarding an actual amount of unrealized capital gains associated with each financial product that is part of the current investments held, wherein the actual amount is positive for at least one financial product that is part of the current investments held;

the one or more processors determining one or more tax characteristics associated with each financial product in the set of one or more financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product; and

the one or more processors formulating advice regarding a recommended portfolio of financial products from the set of one or more financial products, the advice including a recommendation with respect to which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held by performing a portfolio optimization process that selects the financial products for inclusion in the recommended portfolio based at least in part upon the information regarding the current investments, the one or more tax characteristics, one or more relevant financial circumstances of the investor and tax implications of holding the one or more financial products in the taxable account versus the tax deferred account.

2. The method of claim 1, wherein said determining one or more tax characteristics comprises assigning weights to each of a plurality of mutual funds of the set of one or more financial products available for investment by preferring mutual funds with a tax characteristic indicating tax efficiency and using the weights to divide wealth among the plurality of mutual funds.

3. The method of claim 1, wherein said determining one or more tax characteristics comprises:

estimating assets owned by a mutual fund of the set of one or more financial products available for investment based on historical fund performance; and

determining a tax characteristic of the mutual fund based on whether the estimated assets have a propensity to be taxed at a marginal tax rate or a long-term capital gains rate.

4. The method of claim 3, wherein said determining one or more tax characteristics comprises setting a tax characteristic to indicate low tax efficiency if the assets are estimated to comprise income-generating securities or dividend-paying equities.

5. The method of claim 1, wherein said determining one or more tax characteristics comprises:

observing a turnover of a mutual fund of the set of one or more financial products available for investment; and

setting a tax characteristic of the mutual fund based on the observation.

6. The method of claim 5, wherein said determining one or more tax characteristics comprises setting a tax characteristic to indicate low tax efficiency if the turnover is high.

7. The method of claim 1, wherein said determining one or more tax characteristics comprises:

observing historical taxable distributions of a mutual fund of the set of one or more financial products available for investment; and

determining a tax characteristic of the mutual fund based on the observation.

8. The method of claim 7, wherein said determining one or more tax characteristics comprises determining a tax characteristic to indicate low tax efficiency if the historical taxable distributions are high.

9. The method of claim 7, wherein the historical taxable distributions comprise dividends.

10. The method of claim 1, wherein a relevant financial circumstance of the one or more relevant financial circumstances comprises a marginal tax rate of the investor.

11. The method of claim 1, wherein at least one of the set of one or more financial products is a municipal bond mutual fund, and the one or more relevant financial circumstances include a marginal state tax rate of the investor.

12. The method of claim 2, further comprising placing wealth allocated to each mutual fund of the plurality of mutual funds into one or more of the plurality of accounts based on the tax treatment of the plurality of accounts.

13. The method of claim 12, wherein the plurality of accounts include one or more of a taxable brokerage account, an individual retirement account (IRA), an individual tax-advantaged account, an employer-sponsored account, a 401(k) account and a 403(b) account.

14. A method of financial product selection comprising:

one or more processors of one of more computer systems dividing available wealth in a portfolio to be invested by an investor into a new money pool and an old money pool, the new money pool representing a portion of the available wealth not previously invested, and the old money pool representing a portion of the available wealth already invested; and

the one or more processors determining a recommended portfolio of financial products available to the investor for investment in one or more accounts by selecting the financial products with a portfolio optimization process that implements an old money strategy and a new money strategy, the old money strategy allocating the available wealth in the old money pool among the available financial products (i) based at least in part upon an actual amount of unrealized capital gains on individual investments currently owned by the investor, wherein the actual amount is positive for at least one individual investment and (ii) taking into consideration tax effects of transactions during the portfolio optimization process, the new money strategy allocating the available wealth in the new money pool among the available financial products.

15. The method of claim 14, wherein the old money strategy comprises giving capital loss assets full basis.

16. The method of claim 14, wherein the old money strategy comprises using minimum investment constraints to guard against transaction costs outweighing transaction gains.

17. The method of claim 14, wherein the new money strategy comprises giving all assets full basis.

18. The method of claim 14, wherein said selecting the financial products comprises selecting the financial products according to a combined strategy wherein the combined strategy uses new contributions to rebalance the portfolio.

19. A method comprising:

one or more processors of one or more computer systems receiving information regarding each of a plurality of financial products available for investment by an investor in a plurality of accounts, including at least one taxable account of the investor and at least one tax-deferred account of the investor;

the one or more processors receiving information regarding an amount of wealth of the investor that is available for investment including information regarding current investments held in each of the plurality of financial products and in which of the plurality of accounts;

the one or more processors programmatically determining one or more tax characteristics associated with each of the plurality of financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product;

the one or more processors programmatically determining a recommended portfolio of one or more financial products of the plurality of financial products and appropriate allocations among the one or more financial products by performing a portfolio optimization process that selects the one or more financial products for inclusion in the recommended portfolio based at least in part upon the current investments, the one or more tax characteristics of each of the plurality of financial products, one or more relevant financial circumstances of the investor, an actual amount of unrealized capital gains associated with each of the current investments, wherein the actual amount is positive for at least one investment of the current investments;

the one or more processors programmatically determining an account recommendation with respect to which of the plurality accounts each of the one or more financial products in the recommended portfolio should be held based on tax implications for the investor; and

the one or more processors formulating advice for the investor based on the recommended portfolio and the account recommendation.

20. The method of claim 19, wherein the plurality of financial products includes stocks, bonds and mutual funds.

21. The method of claim 20, further comprising:

dividing the available wealth into a new money pool and an old money pool, the new money pool representing a portion of funds not previously invested, and the old money pool representing a portion of funds already invested; and

wherein said programmatically determining a recommended portfolio involves allocating the available wealth in the old money pool according to an old money strategy, which takes into consideration capital gains on investments currently owned by the investor, and allocating the available wealth in the new money pool according to a new money strategy.

22. The method of claim 20, wherein the portfolio optimization process adjusts returns for those of the plurality of financial products held in the at least one taxable account to take into consideration expected tax effects for both accumulations and distributions.

23. The method of claim 19, wherein the recommended portfolio determined by the portfolio optimization process is one that maximizes a utility function of the investor and takes into consideration a risk tolerance of the investor.

24. A method comprising:

one or more processors of one or more computer systems receiving information regarding each financial product of a set of financial products available to a particular investor for investment in a plurality of accounts of the particular investor having different tax treatment, the plurality of accounts including at least a taxable account and a tax-deferred account of the particular investor;

the one or more processors receiving information regarding an amount of wealth of the particular investor that is available for investment including information regarding current investments held in each financial product of the set of financial products and in which of the taxable account or the tax-deferred account the current investments are held;

the one or more processors programmatically determining one or more tax characteristics associated with each financial product of the set of financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product;

the one or more processors programmatically determining feasible exposures to a plurality of asset classes achievable by the particular investor by determining a combination of one or more asset classes of the plurality of asset classes and proportions thereof that characterize future performance of each financial product of the set of financial products;

the one or more processors programmatically determining a recommended portfolio of one or more financial products of the plurality of financial products and appropriate allocations among the one or more financial products by performing a portfolio optimization process that selects the one or more financial products for inclusion in the recommended portfolio by maximizing an expected utility of wealth for the particular investor taking into consideration the feasible exposures, the current investments, the one or more tax characteristics of each financial product of the set of financial products, one or more relevant financial circumstances of the investor, an actual amount of unrealized capital gains associated with each of the current investments, wherein the actual amount is positive for at least one investment of the current investments;

the one or more processors programmatically determining an account recommendation with respect to which of the taxable account and the tax deferred account each of the one or more financial products in the recommended portfolio should be held based on tax implications for the particular investor of holding the one or more financial products in the taxable account versus holding the one or more financial products in the tax deferred account; and

the one or more processors formulating advice for the particular investor based on the recommended portfolio and the account recommendation.

25. The method of claim 24, wherein the set of financial products includes stocks, bonds and mutual funds.

26. The method of claim 24, further comprising:

dividing the amount of wealth into a new money pool and an old money pool, the new money pool representing a portion of funds not previously invested, and the old money pool representing a portion of funds already invested; and

wherein said programmatically determining a recommended portfolio involves allocating wealth in the old money pool according to an old money strategy and allocating wealth in the new money pool according to a new money strategy.

27. The method of claim 24, wherein the portfolio optimization process adjusts returns for those of the set of financial products held in the taxable account to take into consideration expected tax effects for both accumulations and distributions.

28. The method of claim 24, wherein the plurality of accounts include one or more of a taxable brokerage account, an individual retirement account (IRA), an individual tax-advantaged account, an employer-sponsored account, a 401(k) account and a 403(b) account.

29. A method comprising:

a step for receiving by one or more processors of one or more computer systems information regarding each financial product of a set of one or more financial products available for investment in a plurality of accounts of an investor having different tax treatment, the plurality of accounts including a taxable account and a tax deferred account;

a step for receiving by the one or more processors information regarding current investments held in the taxable account and the tax deferred account, including information regarding an actual amount of unrealized capital gains associated with each financial product that is part of the current investments held, wherein the actual amount is positive for at least one financial product that is part of the current investments held;

a step for determining by the one or more processors one or more tax characteristics associated with each financial product in the set of one or more financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product; and

a step for formulating advice by the one or more processors regarding a recommended portfolio of financial products from the set of one or more financial products, the advice including a recommendation with respect to which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held by performing a portfolio optimization process that selects the financial products for inclusion in the recommended portfolio based at least in part upon the information regarding the current investments, the one or more tax characteristics, one or more relevant financial circumstances of the investor and tax implications of holding the one or more financial products in the taxable account versus the tax deferred account.

30. A financial advisory system comprising:

a storage device having stored therein a portfolio optimization routine configured to select financial products from a plurality of financial products available to an investor for inclusion in a recommended portfolio; and

one or more processors coupled to the storage device configured to execute the portfolio optimization routine to formulate advice regarding the recommended portfolio based on information regarding current investments held in a taxable account of the investor and a tax deferred account of the investor, one or more tax characteristics associated with each financial product of the plurality of financial products, one or more relevant financial circumstances of the investor and tax implications of holding financial products of the plurality of financial products in the taxable account versus the tax deferred account, where;

the plurality of financial products is available for investment in a plurality of accounts of the investor having different tax treatment, including the taxable account and the tax deferred account;

the information regarding current investments held in the taxable account and the tax deferred account includes information regarding an actual amount of unrealized capital gains associated with each financial product that is part of the current investments held, wherein the actual amount is positive for at least one financial product that is part of the current investments held;

the one or more tax characteristics are determined by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product; and

the advice includes a recommendation with respect to which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held.

31. A computer-readable storage medium tangibly embodying a set of instructions, which when executed by one or more processors of one or more computer systems, cause the one or more processors to:

receive information regarding each financial product of a set of one or more financial products available for investment in a plurality of accounts of an investor having different tax treatment, the plurality of accounts including a taxable account and a tax deferred account;

receive information regarding current investments held in the taxable account and the tax deferred account, including information regarding an actual amount of unrealized capital gains associated with each financial product that is part of the current investments held, wherein the actual amount is positive for at least one financial product that is part of the current investments held;

determine one or more tax characteristics associated with each financial product in the set of one or more financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product; and

formulate advice regarding a recommended portfolio of financial products from the set of one or more financial products, the advice including a recommendation with respect to which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held by performing a portfolio optimization process that selects the financial products for inclusion in the recommended portfolio based at least in part upon the information regarding the current investments, the one or more tax characteristics, one or more relevant financial circumstances of the investor and tax implications of holding the one or more financial products in the taxable account versus the tax deferred account.

32. A method comprising:

receiving, by one or more software modules, information regarding each financial product of a set of one or more financial products available for investment in a plurality of accounts of an investor having different tax treatment, the plurality of accounts including a taxable account and a tax deferred account;

receiving, by the one or more software modules, information regarding current investments held in the taxable account and the tax deferred account, including information regarding an actual amount of unrealized capital gains associated with each financial product that is part of the current investments held, wherein the actual amount is positive for at least one financial product that is part of the current investments held;

determining, by the one or more software modules, one or more tax characteristics associated with each financial product in the set of one or more financial products by evaluating one or more of information regarding distributions by the financial product and information regarding turnover associated with the financial product;

formulating advice, by the one or more software modules, regarding a recommended portfolio of financial products from the set of one or more financial products, the advice including a recommendation with respect to which of the taxable account and the tax deferred account each financial product in the recommended portfolio should be held by selecting the financial products for inclusion in the recommended portfolio based at least in part upon the information regarding the current investments, the one or more tax characteristics, one or more relevant financial circumstances of the investor and tax implications of holding the one or more financial products in the taxable account versus the tax deferred account; and

wherein the one or more software modules are implemented in one or more processors of one or more computer systems and one or more computer-readable storage media of the one or more computer systems, the one or more computer-readable storage media having instructions tangibly embodied therein representing the one or more software modules that are executable by the one or more processors.

33. The method of claim 32, wherein said determining, by the one or more software modules, one or more tax characteristics comprises assigning weights to each of a plurality of mutual funds of the set of one or more financial products available for investment by preferring mutual funds with a tax characteristic indicating tax efficiency and using the weights to divide wealth among the plurality of mutual funds.

34. The method of claim 32, wherein said determining, by the one or more software modules, one or more tax characteristics comprises:

estimating assets owned by a mutual fund of the set of one or more financial products available for investment based on historical fund performance; and

determining a tax characteristic of the mutual fund based on whether the estimated assets have a propensity to be taxed at a marginal tax rate or a long-term capital gains rate.

35. The method of claim 34, wherein said determining, by the one or more software modules, one or more tax characteristics comprises setting a tax characteristic to indicate low tax efficiency if the assets are estimated to comprise income-generating securities or dividend-paying equities.

36. The method of claim 32, wherein said determining, by the one or more software modules, one or more tax characteristics comprises:

observing a turnover of a mutual fund of the set of one or more financial products available for investment; and

setting a tax characteristic of the mutual fund based on the observation.

37. The method of claim 36, wherein said determining, by the one or more software modules, one or more tax characteristics comprises setting a tax characteristic to indicate low tax efficiency if the turnover is high.

38. The method of claim 32, wherein said determining, by the one or more software modules, one or more tax characteristics comprises:

observing historical taxable distributions of a mutual fund of the set of one or more financial products available for investment; and

determining a tax characteristic of the mutual fund based on the observation.

39. The method of claim 38, wherein said determining, by the one or more software modules, one or more tax characteristics comprises determining a tax characteristic to indicate low tax efficiency if the historical taxable distributions are high.

40. The method of claim 38, wherein the historical taxable distributions comprise dividends.

41. The method of claim 32, wherein a relevant financial circumstance of the one or more relevant financial circumstances comprises a marginal tax rate of the investor.

42. The method of claim 32, wherein at least one of the set of one or more financial products is a municipal bond mutual fund, and the one or more relevant financial circumstances include a marginal state tax rate of the investor.

43. The method of claim 33, further comprising placing wealth allocated to each mutual fund of the plurality of mutual funds into one or more of the plurality of accounts based on the tax treatment of the plurality of accounts.

44. The method of claim 43, wherein the plurality of accounts include one or more of a taxable brokerage account, an individual retirement account (IRA), an individual tax-advantaged account, an employer-sponsored account, a 401(k) account and a 403(b) account.