Nerd's Eye View blog

Ten Charts To Help Address Client Concerns On Recession Fears, Tariff Risks, And Market Volatility

March 26, 2025 07:03 am 0 Comments CATEGORY: Investments

While financial markets tend to rise in the long run, short-term volatility can be alarming for investors. Recent swings have been driven by economic policy shifts, persistent inflation concerns, and geopolitical uncertainty – all of which may unnerve even the steadiest of clients. During turbulent periods like these, advisors play a critical role in helping clients maintain perspective and stay grounded.

In this article, James Liu, CEO and founder of Clearnomics, and Lindsey Bell, the firm's Chief Market Strategist, present ten charts to help advisors contextualize the current market environment. Each visual is paired with talking points designed to help advisors reframe volatility in a way that speaks to clients' concerns.

As a starting point, it's helpful to reinforce that investing success isn't about timing the market or picking winning stocks, sectors, or asset classes. Rather, it's about constructing a portfolio that aligns with a client's long-term goals. While stocks have recently declined, bond yields are above historical averages – highlighting the importance of maintaining a diversified mix. And while cash can feel safe, it often fails to keep pace with inflation, especially in turbulent markets. In that same vein, diversification remains the core of a healthy portfolio to protect against market corrections and underperformance, as no single asset class outperforms indefinitely.

It may also be helpful to discuss the drivers of current market corrections. Advisors might acknowledge that inflation and political uncertainty often elicit market reactions, and that many economic policy decisions can be controversial and divide public opinion. Nevertheless, history shows that markets have performed well under both political parties. Much of what's happening now reflects companies adapting to present-day challenges – from higher input costs to shifting consumer demand. Advisors can guide clients' attention to where growth is happening and to areas of economic resilience – such as persistently low unemployment – that are often overlooked in negative news cycles.

Finally, advisors can emphasize that while market corrections never feel good, they are a natural part of the investing cycle – just like market recoveries. And because recoveries are difficult to time, the best thing investors can do is to stay the course and focus on long-term goals. Advisors are uniquely positioned to offer not only perspective and education, but also empathy and reassurance during tough market periods when clients may need it most.

The key point is that challenging market environments give advisors the opportunity to tailor talking points to a client's specific anxieties. Being well-informed about the market influences, remaining empathetic, and maintaining a long-term perspective are all crucial to guiding clients through market corrections. And, while unpleasant, tough market conditions offer a way for advisors to explain the critical role of a well-diversified portfolio, demonstrate their knowledge, and ultimately affirm their long-term value!

#FASuccess Ep 430: Navigating The Fast-Growth Hiring Challenges Of Scaling From Scratch To $5M Of Revenue In Just 7 Years, With AJ Ayers

March 25, 2025 07:03 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome everyone! Welcome to the 430th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is AJ Ayers. AJ is the co-founder of Brooklyn Fi, an RIA based in Brooklyn, New York but operating as a fully remote business, that oversees $370 million in assets under management for more than 400 client households.

What's unique about AJ, though, is how she and her business partner have navigated the hiring and training, and system and process challenges, that come from very rapidly scaling an advisory firm business from scratch to $5 million of revenue in just 7 years.

In this episode, we talk in-depth about how AJ and her firm have navigated periods of rapid client headcount growth (with the firm averaging 14 new clients per month in 2021 while having just three planners on staff at the time), how AJ decided to hire rapidly to meet this brisk new client demand (by leveraging LinkedIn's Recruiter platform to actively reach out to potential candidates rather than wait for them to respond to a passive job listing), and how AJ's firm created a training program to bring new hires up to speed more quickly on serving clients in the firm's hyper-specialized equity compensation niche (by incorporating internally produced videos, external coursework, and the opportunity to sit in on client meetings alongside BrooklynFI's lead advisors very early in the new advisor's tenure with the firm).

We also talk about how serving the equity compensation niche has allowed AJ and her firm to rapidly attract new clients and then efficiently systematize its planning process and give its advisors the chance to get lots of ‘at bats' early on working with its target clients, how AJ and her partner further streamlined their firm's planning process by creating a software tool called Gemifi to extract data from a client's grant award statements and then analyze the equity compensation history to offer planning scenarios for how to handle their equity grants, and how AJ has developed a three-part fee model (including a complexity-based planning fee, an AUM fee on investible assets, and a fee for tax-preparation) to ensure that fees best align to each client's unique needs and the value her firm provides in each these areas (and ensure sufficient revenue per client when some of the firm's clients have not yet experienced a liquidity event that would allow them to be served profitably under an AUM-only model).

And be certain to listen to the end, where AJ shares how she and her business partner decided to delegate responsibility for day-to-day firm operations (allowing them to dial back their own founder work schedules to two days per week), why AJ decided to hire an HR professional to serve as a "people person" who could help build company culture in a virtual working environment (including by hosting regular in-person retreats that the whole team flies in for), and how AJ experienced impostor syndrome a couple years into her time in the industry (as she realized how much there was to learn about the equity compensation niche) but tackled it head-on by earning a series of certifications relevant to her niche and trying to get even more client meetings to build experience working with her firm's ideal client.

So whether you're interested in learning about how AJ integrated delegation and training into the infrastructure of her firm, how AJ tackled a complex corner of the industry as a career changer, or how to work scalably in a niche where the clients' day-to-day circumstances are always changing, then we hope you enjoy this episode of the Financial Advisor Success podcast, with AJ Ayers.

From New-Hire To Confident Advisor: Structuring A First-Year Associate Advisor Onboarding Plan To Develop Technical And Client Skills

March 24, 2025 07:01 am 0 Comments CATEGORY: Practice Management

Almost anyone who has onboarded new employees will attest to the inherent balancing act it requires. New advisory firm employees need to learn ‘just a few' things: who their teammates are and how to work productively with them, who the firm serves, what makes the clientele unique, and how to navigate the daily operations and long-term goals of the firm. New associate advisors face an additional learning challenge as they are asked to internalize the hard and soft skills needed to deliver high-quality advice. In short, there's plenty to learn. Yet, new advisors also need opportunities for responsibility and autonomy to progress and remain engaged. For smaller firms – especially those with little to no experience onboarding new advisors – creating a well-paced financial plan can feel daunting. However, a structured and flexible onboarding plan not only helps an associate advisor ramp up efficiently but also ensures a smooth transition into an autonomous and fulfilling role!

In this article, Senior Financial Planning Nerd Sydney Squires discusses how to construct an associate advisor onboarding plan that guides an associate advisor through their first year, establishes clear checkpoints for progress, yet still allows enough flexibility to grow with the new advisor!

A few key principles can make the onboarding process smoother for both the associate advisor and their manager. First, clarity: both the advisor and manager should be able to clearly define the core financial planning skills that a new hire is expected to develop in their first year. Second, measurable progress: the plan needs objective standards and measurable benchmarks so that everyone can track development and stay accountable.. Third, balanced structure and flexibility: while the plan should serve as a clear ‘guiding star' for the new advisor, it also needs room for adjustments as the advisor's strengths and preferences emerge.

One effective way to structure the onboarding process is to organize the skills that the associate advisor will ideally learn in their first year into key categories. We have provided an onboarding plan template for advisors to download, which breaks up the skills list into two primary categories: 1) client communication skills (e.g., meetings, email communication, and phone calls), and 2) technical skills (e.g., building an initial financial plan). As the onboarding template is filled in over the year, the advisor and manager can review the plan during check-ins to assess progress, identify challenges, and highlight what feels most fulfilling in the role. Additionally, having a one-stop reference sheet with resources – such as compliance guidelines and broker-dealer help desk contacts – can minimize routine questions and streamline the learning curve throughout the onboarding process!

The key point is that while onboarding associate advisors is often a highly individualized process in small firms, a clear, structured onboarding plan ensures managers and associates stay focused on the big picture as the advisor learns and takes on new responsibilities at a sustainable pace. Ultimately, a little planning, a collaborative attitude, and strong communication (with a good sense of humor!) can go a long way in developing confident, competent, and autonomous advisors!

Weekend Reading For Financial Planners (March 22–23)

March 21, 2025 01:52 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "Weekend Reading For Financial Planners" – this week's edition kicks off with the news that a report from Cerulli Associates found that, amidst an industry-wide trend towards comprehensive financial planning and away from pure transaction-based investment management, asset-based fees currently represent 72.4% of advisor compensation, while commission-based revenues have declined to 23% of an average advisor's revenue. Which reflects similar results from recently released Kitces Research on Advisor Productivity, which found that asset-based fees are used by 92% of surveyed advisory teams (and are the primary revenue source for 86% of respondents), with 42% using hourly or project fees, 37% offering retainer or subscription fees, and 34% receiving commissions (with some firms offering more than one fee model to attract different client segments).

Also in industry news this week:

While inter-channel advisor moves often make headlines, a recent study from Diamond Consultants found that most advisor transitions occur between firms in the same channel
The number of disciplinary cases and restitution orders from FINRA increased in 2024 (the total amount of fines declined) as the self-regulatory organization focused on violations in areas including trade reporting, options trading, and Regulation Best Interest

From there, we have several articles on investment planning:

A review of historical market crashes shows that the 'pain' for investors is felt not only in the depth of each drawdown, but also in their duration
While investors might view investment success as the product of active decisions they make, it is often the mistakes they avoid that lead to meeting their long-term goals
Why making political bets with investments can be a risky, and challenging, proposition

We also have a number of articles on client communication:

How applying the "ABC model of stress" can better allow advisors to support clients facing stressful situations and also demonstrate their value to prospects
While the constant barrage of news headlines can give clients plenty of reasons to panic, advisors can add value for their clients not only by serving as a steadying voice, but also by being opportunistic when downturns do occur
The key differences between client stress and anxiety and the communication approaches advisors can use to best respond to each

We wrap up with three final articles, all about leadership:

How a "Constant Gentle Pressure" approach can lead to more consistent levels of client service and better relationships between managers and employees
While operating remotely allows firms to access a broader pool of managers (and staff), doing so effectively can require more proactive methods of employee engagement on the part of leaders
How leaders can get better at delegating, from regularly searching for tasks that they don't necessarily have to complete themselves to identifying next-generation leaders whose development could be accelerated by taking on new responsibilities

Enjoy the 'light' reading!

Kitces & Carl Ep 160: Calming Clients With Anxiety About Trump Tariffs And Trade Wars

March 20, 2025 07:02 am 0 Comments CATEGORY: Kitces & Carl Podcast

Whenever the markets become ‘scary' due to current events, advisors can anticipate calls from anxious clients wondering what to do next. These clients are often in fight-or-flight mode, which can make it difficult to have a rational discussion or a productive conversation about their financial plan. And if an advisor jumps straight to data – trying to ‘prove' why staying the course is the right decision – the client may become even more frustrated and reactive. So how can advisors navigate these conversations in a way that helps clients regain a sense of control?

In our 160th episode of Kitces and Carl, Michael Kitces and client communication expert Carl Richards explore how empathy-centered conversations can help clients emotionally reset before engaging in rational decision-making. They discuss a structured five-step framework that financial advisors can use to guide clients from fear back to confidence – helping them feel heard first before introducing logical reasoning.

When a client calls in distress, the first step is to greet them with empathy. If the client says they are worried, it can help to reflect that concern back to them with a simple acknowledgment, such as, "You sound very worried. I feel worried when I watch the news, too." Next, creating space – such as taking a minute to grab a glass of water or introducing a natural pause – can help slow the pace of the conversation and ease tension. Once the client feels more at ease, the advisor can affirm their goals by reinforcing what truly matters to them, such as ensuring they can continue spending a certain amount in retirement. From there, the advisor can remind them that their portfolio was built to support the client's long-term goals and designed to withstand market hiccups, declines, and corrections. Finally, once the emotional intensity has subsided, the advisor can introduce data and historical patterns to provide reassurance.

Still, some clients may insist that "this time it's different". In these cases, it can help to acknowledge that while the cause of each scary market downturn is unique, the market's pattern of recovery has been remarkably consistent. Walking the client through how their individual portfolio would perform in a recession can also be reassuring. Often, the worst-case scenario isn't financial ruin – it may instead be a matter of weathering a few years without an increase to their year-over-year spending. These conversations can also be a great opportunity to affirm why portfolios are structured for risk management, especially since the same client who fears a downturn today may, in a strong market, wonder why they have to rebalance when they could be chasing higher returns!

Ultimately, the key point is that scary markets feel scary – but advisors don't need to rely solely on data to convince clients to stay the course. While historical patterns provide perspective, no one truly knows what will happen next. By leading with empathy and curiosity, advisors can guide clients through market volatility with confidence and care, ensuring they leave conversations feeling heard, understood, and reassured!

Four Questions To Discover ‘Actual’ Risk Tolerance Differences In Couples

March 19, 2025 07:02 am 0 Comments CATEGORY: Client Trust & Communication

Measuring a client's risk tolerance is both an art and a science. Beyond assessing how a client feels in the moment, advisors must evaluate a client's long-term behavioral tendencies, actual risk capacity, and financial goals – all of which require considerable time and skill. These dynamic complexities multiply when working with couples, where each partner has unique preferences and traits and may influence the other's risk-taking behaviors.

Risk tolerance questionnaires alone often fail to capture the full picture of a couple's risk dynamics. While each partner may have distinct preferences and traits, their financial decisions are rarely made in isolation. For example, one person may be highly risk-averse, which can pressure the other to take on more risk to compensate for their partner's behavior. Furthermore, household dynamics often lead one partner to take on the role of "Family Financial Officer", who drives most of the financial decisions while the other partner remains less involved. Yet, even if one partner isn't actively managing finances, they are still affected by saving and spending decisions. And, if they feel overlooked – especially in early stages of working with an advisor – it can increase the likelihood of disengagement.

However, risk tolerance assessments can serve as a valuable tool for building goodwill with both partners – and setting the stage for long-term financial harmony. As a starting point, individual psychometric risk assessments can help identify two key considerations: whether there's a gap between a client's individual questionnaire score and their stated goals, and whether there are significant differences in risk tolerance between the two partners. From there, the advisor can guide clients in productively navigating these differences.

Advisors may want to ask what the client thought about the risk tolerance assessment, encouraging each partner to share their perspectives on financial risk, their past behavior with risk-taking, and their personal 'story' of risk, which can help the advisor better understand how each partner approaches financial decision-making. These conversations also offer an opportunity to discuss preferred communication styles about financial matters (especially in response to market performance). In the short term, focusing on shared priorities can promote alignment, while in the long term, honoring each partner's risk preferences can lead to more balanced financial decisions and a stronger sense of partnership in managing their wealth.

Ultimately, the key point is that a couple's risk tolerance is shaped by a combination of personal history, future concerns, and the ways that partners influence each other. Navigating differences in risk isn't a one-time evaluation but an ongoing conversation. And by proactively addressing these dynamics, advisors can help couples build confidence in their financial decisions and create a strong foundation for collaboration over time!

#FASuccess Ep 429: What It Takes To Really Help (HNW) Business Owners Navigate Their Wealth With Purpose, With Ali Nasser

March 18, 2025 07:02 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome everyone! Welcome to the 429th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Ali Nasser. Ali is the Founder of the Wealth Integration System for Entrepreneurs, an education and coaching company based in Houston, Texas, that works with entrepreneurs facing a liquidity event and trying to figure out what's next… and financial advisors who serve them.

What's unique about Ali, though, is the path of how he built an advisory business by helping (high-net-worth) business owners achieve their financial goals while being true to their entrepreneurial mindset and drive (which can sometimes conflict with ‘standard' financial planning advice), which was so successful that he eventually sold his advisory firm so he could focus in even more deeply with non-advisory coaching and consulting services to entrepreneurs.

In this episode, we talk in-depth about how Ali attracted high-net-worth business-owner clients to his advisory firm by identifying planning gaps created by the client's current investment, tax, and estate advisors who might not have been coordinating their advice on the full breadth of the business owner's tax situation (on issues such as making charitable donations in the most tax-efficient way possible), how doing so helped Ali convince busy business owner prospects to go through a multi-meeting pre-engagement process to further demonstrate the value he provided (and helped both sides understand whether they would be a good client-advisor fit), and Ali's financial planning process itself (which could include eight meetings over the course of six to nine months) for mapping a path to what he calls "independent wealth" for his entrepreneur clients (as a way to facilitate them finding a better balance between their work and personal lives).

We also talk about how Ali approaches the delicate issue of concentration risk when working with entrepreneurs (who often have a deep emotional attachment to their business and might be hesitant to pull money out of it, despite it making up a very disproportionately large percentage of their net worth), how Ali helps business-owner clients overcome the "paradigm gap" of reluctance to invest in the broader stock market (preferring to continue reinvesting in their business instead) by framing index investing as a way to tap into the best entrepreneurial minds in the country but in a diversified and hands-off manner, and how Ali finds that (despite their sometimes very significant wealth), many business-owner clients still have to overcome feelings of financial scarcity (given how many high-net-worth entrepreneurs come from very financially difficult backgrounds).

And be certain to listen to the end, where Ali shares how, as an advisory firm owner, he sought out feedback not just from "squeaky wheel" clients but the ones who best represented the target avatar of client he wanted to serve (to better understand how to find and serve those clients he wanted to replicate), how Ali found that the hardest parts of being an entrepreneur himself were getting other team members on board with delivering the same level of experience that he as the founder wanted to provide to clients (and the subsequent challenge of letting employees go when they aren't a good fit to deliver up to those standards), and how Ali's own entrepreneurial journey led him to sell his advisory firm and focus full-time on coaching business-owners and the advisors working with them because, as he puts it, "the gems are in the details" of the process needed to really serve entrepreneur clients and their needs effectively.

So, whether you're interested in learning about attracting high-net-worth business-owner clients, how to handle the topic of concentration risk with entrepreneur clients, or strategies for receiving valuable and actionable client feedback, then we hope you enjoy this episode of the Financial Advisor Success podcast, with Ali Nasser.

AI Meeting Notes Tools For Financial Advisors: Solo Productivity Vs Associate Advisor Development?

March 17, 2025 07:02 am 0 Comments CATEGORY: Technology & Advisor FinTech

With each passing decade, not only does technology evolve at an ever more dramatic pace, but each new wave comes faster than the last. From the advent of the computer chip in the 1950s to the rise of the personal computer nearly 25 years later in the early 1980s, to the emergence of the internet just 15 years thereafter in the late 1990s, to mobile smartphones only 10 years after that in the late 2000s, to 'robos' less than a decade later in the 2010s, and most recently to AI, which 'suddenly' went mainstream in late 2022 when ChatGPT burst onto the scene – the pace of technological change seems to be accelerating inexorably. And with the advent of AI in particular, questions have emerged about whether technology will replace many human jobs, including financial advisors.

Yet now, two years later, AI has not driven a mass wave of unemployment. Instead, it's being allocated to far more specific – but still very relevant and helpful – use cases that don't replace professional service providers and instead simply leverage their time to be even more efficient. In the case of financial advisors in particular, this has included everything from using ChatGPT as a brainstorming buddy for developing an advisor marketing plan, to generating a first draft of a client newsletter (as it's far easier to edit something already there than to write on a blank slate), to adopting what has quickly become the hottest AI-driven solution in advisor technology: AI Notetakers to support the client meeting.

In practice, rapid adoption of AI Notetakers has been expedited both by the media's fixation on Artificial Intelligence (which has highlighted a wide range of AI solutions like Fathom, Fireflies, and Otter) and by the rollout of AI Notetakers within existing platforms (from Microsoft's CoPilot to Zoom's AI Companion). But when it comes to financial advisors, our own Kitces Research on Advisor Productivity shows that while some of the "generic" solutions have gained market share the fastest, it turns out that the industry-specific solutions like Jump and Zocks lead in advisor satisfaction (while ironically, #1-adopted Zoom AI Companion actually ranks the lowest!). This is largely because, for financial advisors, it's not 'just' about capturing notes from the client meeting itself, but also about managing everything that follows: recording meeting notes in the CRM for compliance purposes, assigning post-meeting tasks to the team, and sending the client a post-meeting recap email. For which industry-specific providers are building the entire advisor-CRM-integrated workflow.

Yet the irony is that for many advisors, saving time on client meeting notetaking is difficult when those tasks have already been delegated – to the team's Associate Advisor. In fact, as our Kitces Research data shows, adoption of AI Meeting Notes tools has been most common amongst "pure solo" advisors, who have no one to delegate to (and instead find great leverage in delegating to an AI Notetaker). Nonetheless, AI Notetakers are not just for solo advisors; instead, they're also increasingly popular amongst larger (e.g., four to five person) teams, where it's easier to share out the AI's post-meeting notes to get everyone on the team (who may not have been in the meeting) up to speed. In addition, AI Notetakers are increasingly popular as advisors' financial plans get increasingly comprehensive; not surprisingly, the more detailed financial planning conversations happen in client meetings, the more there is to capture and share out.

At the same time, AI Meeting Notes tools themselves continue to evolve rapidly. What wasn't even a category of software just two years ago has now raised tens of millions of dollars in just the AdvisorTech domain alone, for what is not only nominally "notetaking" software, but increasingly covering the entire client meeting lifecycle (meeting notes → record notes in CRM → queue up post-meeting tasks → draft post-meeting recap email →→→ pre-meeting agenda for the next client meeting), and then leveraging the cumulative data to provide even more recall details for advisors about what happened in prior meetings.

In the long run, it seems clear that AI Meeting Notes tools are here to stay. In fact, with their increasingly comprehensive coverage of the entire client relationship, perhaps the biggest question is simply whether they'll remain standalone tools or, instead, if CRM systems for financial advisors will eventually offer their own built-in versions (since that's where the rest of the data about client relationships already resides!?).

Either way, the landscape of AI in advisor technology continues to evolve fast. And we're committed to keeping track of it with our Kitces Research. Which is why we're also launching our latest Kitces AdvisorTech survey, to collect data on the latest in how advisors are actually using technology. So if you have a few minutes, please take our AdvisorTech survey linked at the end of this article!

Weekend Reading For Financial Planners (March 15–16)

March 14, 2025 02:00 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "Weekend Reading For Financial Planners" – this week's edition kicks off with the news that Securities and Exchange Commission (SEC) Commissioner Hester Peirce suggested in a recent interview that she would like to see the SEC give advisors more leeway to provide customized solutions to clients (rather than feeling required to take a regulator-prescribed "check-the-box" approach) and would like to ease the compliance burden on smaller investment advisers (perhaps expanding the SEC's definition of small firm in the process) to reduce the entry and operational barriers for these firms. Which, if implemented under the new administration, could provide relief for investment advisers, particularly smaller firms that already have to balance compliance with client service, marketing, and the other duties that go into running a firm.

Also in industry news this week:

A recent survey finds that while advisors are increasingly using passive investment vehicles, many are taking the time to look beneath the hood to examine the makeup of different indexes in order to choose the best option for their clients
A survey of advisors working at enterprise firms shows a significant increase in their adoption of artificial intelligence tools over the past year, with common use cases including predictive analytics, marketing, and summaries of meeting notes

From there, we have several articles on Social Security:

The Social Security Administration has reversed a policy enacted last year that limited overpayment 'clawbacks' to 10% of monthly benefits, which will have the effect of reducing the monthly payments of some Social Security recipients to $0 until the overpayment is recovered
How the relationship between income and longevity could play a role in policy efforts to raise the Full Retirement Age in order to help shore up the Social Security system
A white paper shows the impact (in dollar terms) for clients of various proposals to put Social Security on sustainable footing

We also have a number of articles on practice management:

As growth-driven (rather than retirement-driven) RIA M&A activity increases, deal terms and cultural fit (and not 'just' headline valuations) are becoming increasingly relevant
Why a "curated cultural competition" with limited suitors rather than an "auction" focused on price could better serve the interests of RIA buyers and sellers alike
How firms can approach unsolicited acquisition offers, from analyzing the different compensation elements being offered to assessing whether the buyer shares a similar approach to financial planning

We wrap up with three final articles, all about building better habits:

12 ways to build better habits, from breaking big goals down into smaller chunks to sharpening the ability to say "no" to opportunities that might distract from the goal at hand
How "commitment strategies" can reduce the amount of willpower required to start and maintain new habits
How running "tiny experiments" can help individuals build better habits while viewing their progress from a more impartial perspective

Enjoy the 'light' reading!

Using Section 351 Exchanges To Tax-Efficiently Reallocate Portfolios With Embedded Gains

March 12, 2025 07:01 am 0 Comments CATEGORY: Taxes

Following the long run-up in the US equity markets since the bottom of the 2008–2009 financial crisis, many investors with taxable investment accounts have likely found themselves with high embedded gains in their portfolios. While the gains signal portfolio growth, they also create challenges for ongoing management. Because when it comes time to rebalance the portfolio to its asset allocation targets – or to reallocate the portfolio to a new strategy – any trades made to implement those changes can generate capital gains, resulting in tax consequences for the investor.

Once a portfolio becomes 'locked up', i.e., unable to be managed without triggering capital gains, investors' options become limited. Charitably inclined investors can donate appreciated securities and avoid gains on the sale. If they don't plan to use the portfolio funds in their lifetime, they could simply hold the assets for heirs to preserve the stepped-up basis. Otherwise, the investor would traditionally have had to accept that taxes would impose a drag on their portfolio performance going forward.

One relatively new strategy, the Section 351 exchange, allows some investors to reallocate assets without triggering capital gains tax. Section 351 allows for tax deferral when assets are transferred to a corporation in exchange for that corporation's stock, provided the transferor owns at least 80% of the corporation following the exchange. Although the concept of Section 351 exchanges has existed for over a century, it has only recently been applied to individual investment portfolios.

The strategy works by pooling the portfolios of multiple investors in a newly created ETF, with the investors receiving ETF shares in return for the assets that they contributed. If the exchange meets the requirements of Section 351, it is tax-deferred for investors. And once inside the ETF 'wrapper', assets can be reallocated with no tax impact for the investors via the tax-efficient ETF structure, which makes use of in-kind creation and redemption of shares. In effect, investors can effectively trade a locked up for an ETF that can be managed with little or no tax impact at all!

However, to meet the requirements for tax-deferred treatment under Section 351, each investor's portfolio must meet a diversification test, where no single asset can exceed 25% of the portfolio's value and the top five holdings cannot exceed 50% of the overall value. Additionally, certain assets, like mutual funds, alternative assets, and REITs, may not be eligible for exchange, although other ETFs generally are.

For financial advisors, Section 351 exchanges present a potential solution for clients with high embedded gains, such as those who through the use of tax-loss harvesting have lowered their portfolios' basis to the point where it's no longer possible to harvest any losses to offset the gains realized in reallocating the portfolio. Recently, several ETF sponsors have launched ETFs seeded in-kind by individual investors, creating a new channel for advisors who want to take advantage of Section 351 exchanges for clients. Some providers even offer services to help advisors launch their own ETFs seeded by their clients' funds.

While the options for Section 351 exchanges remain limited – and some advisors may not yet be comfortable recommending them due to their short track record – the strategy is still worth watching. If it gains traction, it could be a helpful tool for advisors to implement more tax-efficient investment strategies – while overcoming the inconvenient tax friction of implementing the strategy to begin with!