How Financial Advisors Can Deliver Tax-Savvy, Evidence-Driven Value

Flat Rock Wealth Partners, a registered investment advisory firm, has taken a comprehensive approach to wealth management for its clients since its founding in 2022, incorporating charitable giving and tax planning into its strategies.

Co-founder of Flat Rock Wealth Partners, John West, provides a new perspective on the effectiveness (or ineffectiveness) of model portfolios for its wealth clients. West also explains why taxes can often cause overlooked friction when it comes to investing and some tactics to relieve that friction.

These and more of John’s insights can be used by financial advisors to better inform their strategies with clients.

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John West found his way into pension consulting after graduating from the University of Arizona with a degree in Finance and a surprising but notable appearance in college basketball history. “Pension consulting is basically doing the exact same thing financial advisors do ...,” John said. “Asset allocation, risk tolerance, manager selection, performance measurement, and so forth, but doing it for institutions.”

In the span of 10 years, he grew from an analyst to leading capital markets research and the endowment practice at Varus, a national institutional investment consulting firm. He then worked for 15 years driving growth at Research Affiliates, a global asset manager, leading all client-facing activities and product management there before moving on to co-found Flat Rock Wealth Partners in 2022.

John’s movement through the investment management space, from institutional to wealth clients, has given him a unique point of view when it comes to portfolio construction, the impact of taxes, and even tech.

Ironically, one of John’s most interesting takes is his stance on being honest with clients versus simply serving up “interesting” bits of information on capital markets, economic forecasting, and current events. He prefers to err on the side of honesty when communicating to clients the hard truth that no investment manager or any financial advisor can predict the future with absolute certainty.

“Frankly, it doesn't matter to producing solid, long-term financial outcomes,” John said. “There's this tremendous bias to talking about markets rather than focusing on what matters and what drives long-term returns.”

John noted model portfolios do not serve many of Flat Rock’s clients well because each one’s financial situation is so unique.

“Oftentimes, clients will come in with low-basis legacy positions,” John explained. “You can't just blow out of those to fit them into a model and realize a big capital gain.”

John added, “Another factor that affects the choice to use a model portfolio is the ratio of the client’s tax-deferred assets to tax assets. If an investor holds 80% of their wealth in an IRA and 20% in a brokerage account, for example, an advisor should offer very different guidance than they would if the ratio were reversed.”

The last factor John flagged was tax regimes. “If someone's in Texas, I think a model built for someone in California is going to produce probably suboptimal results,” he said.

This individualized and honest approach is where John emphasized advisors should begin with clients.

From the start, Flat Top Wealth Partners does not follow the typical route of beginning with a client’s goals and risk tolerance. Bold predictions can be impressive, but long-term performance is what really matters. West said he often asks clients whether they want anecdotes or evidence to define their investment success. More often than not, the response is evidence.

“Most of our clients are in their 40s and 50s, and frankly, they've spent the last 20 years concentrating on their careers, concentrating on their loved ones, perhaps raising a family,” John said. “They don't even know what their goals are, so the first thing we do is we just put everything down on one page that supports their life financially.”

He clarifies this exercise is not about net worth. Rather, it’s things like the current value of their social security, estate inflows they’re going to have, and most importantly, the value of their human capital. This means how much in future wages and earnings they expect to receive.

From there, it’s about priorities; what does the client want this capital to support?

“In our mind, a great life is supporting the people, passions, and purpose that lead to a happy and fulfilled existence,” he said. “By putting everything down on one page, we can really be intentional on making sure that people are getting what they want out of their money.”

John brought up the success of a former college basketball coach for the University of California, Los Angeles, John Wooden, and this coach’s unique method for starting the first practice of the season. Each year, Wooden would walk out barefoot in front of all his players and staff, roll out a pair of socks, and show them how to put them on. Wooden knew putting socks on wrong leads to blisters, which leads to bad performance.

Using this basketball analogy West illustrated how little moves can make a big difference in making clients’ cash work for them. For example, many of Flat Rock’s clients have high cash balances and might trust it to a brokerage house. That broker might place a client’s money in something like a prime money market fund where the client is being taxed on the interest at the state level and the broker is benefiting.

Instead, choosing something like a money market fund based in treasuries could save the client from paying income tax at the state level in some cases. Similar benefits could come from exchange-traded funds or T-bills.

This might seem small, or even once again, an uninteresting point to focus on, remember athletes with blisters tend to play poorly compared to those who put their socks on properly.

“Being aware of the frictions in investing is crucial,” John said, as he also credits the fund industry for its mindfulness toward fees over the years but not necessarily taxes.

West called out the disconnect between taxes and investment returns. Plainly put, fees and taxes, despite their individual complexities, are two of the most predictable factors in investing, but returns are not.

While you can’t concretely predict investment returns, even over the long term, you can control fees and estimate taxes. So, taxes should be part of an advisor’s process. This means implementing tactics such as:

• Estimating how much taxes are likely to take from an asset class or strategy
• Understanding where returns come from and incorporating that into asset-class forecasting
• Taking control by using vehicles like ETFs, direct indexing, and separately managed accounts to let you determine when to pay gains

“You want to have the flexibility to realize gains when it's most advantageous to you, and to hold off realizing gains when it's most advantageous to the taxing authorities,” John said.

John had four main questions to consider when measuring success with clients. These questions include:

• “Do we have enough?” - Break down what money means to the client, and most often it comes down to one of two answers. Either money means freedom, or it means security, which leads seamlessly into the next question.
• “Are we protected?” - This question and the former are best answered in a client’s financial planning process.
• “Are we structured appropriately?” - Go back to the idea of control. Considerations like, should I use an ETF? Should I use direct indexing? Should I place this asset in an IRA or in a taxable account? These come into play with this question.
• “Are we investing efficiently?” - Think about whether or not you’re using all the research and tools available to you to build a smart portfolio.

If all four questions can be answered with a yes, then you’re doing your job, according to John. He adds that saving clients time and offering a redundancy of investment expertise are other areas to prioritize when measuring success with clients.

John and Flat Rock Wealth Partners’ back-to-basics, holistic approach to wealth management and portfolio construction might ironically be the fresh perspective clients need.