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I had two conversations this week with listeners who had built meaningful wealth and believed strongly in keeping their investments simple. Both were dealing with a problem that a basic portfolio could not completely solve.
One owned a concentrated position he wanted to diversify. The other knew a large taxable gain was coming and wanted to know whether anything could soften the impact.
Neither was eager to add another strategy. They were cautious about investing in something they could not personally explain, and skeptical of sophisticated investments that sound clever but turn out to be expensive gimmicks.
I share that instinct.
Ask me whether I prefer simple or complex, and I will choose simple every time. But the goal is not to own the simplest portfolio imaginable. It is to use the simplest portfolio capable of solving the problems you actually have.
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Why a Simple Investment Portfolio Can Fall Short as Wealth Grows
Simple investing has gained a lot of traction since the Great Financial Crisis, and for good reason. Index funds, rules-based strategies, and better technology made broad diversification inexpensive and easy.
In a previous episode, I argued that basic market exposure has become cheap and standardized. That is true—but it is not the same as saying every investor’s financial problems have become simple.
But something changes after you accumulate meaningful wealth. Your portfolio may still look simple while your financial life becomes more complicated.
You may have company stock with a low cost basis, a business sale approaching, a large gain coming, or decisions that interact across your investments, taxes, and estate plan.
Meanwhile, the same technology that made simple portfolios cheaper has also made specialized strategies less expensive and more accessible.
How to Decide When Investment Complexity Is Worth It
One of the four steps in the decision framework in my new book, The Perfect Portfolio, asks: Does this introduce unnecessary complexity?
The key word is unnecessary. Complexity is not automatically disqualifying. It becomes a problem when it adds costs, risks, or moving parts without solving something important.
The simple solution should always get the first look. A more complex strategy carries the burden of proof. It needs to solve a real problem, provide enough potential value after costs and risks, and fit with the rest of the plan.
Imagine someone who owns $3 million of one stock with a cost basis of $300,000. The simplest answer is to sell it (whether that’s all at once or spread out over time), realize a $2.7 million gain, pay the tax, and reinvest in a diversified portfolio.
That may be the right answer. But with a gain that large, it is reasonable to compare it with other possibilities.
Direct Indexing and Long-Short SMAs for Managing Capital Gains
The first group of strategies I discussed with these two separate individuals last week involved creating capital losses to offset gains.
A separately managed account, sometimes described as direct indexing, owns the individual stocks in an index rather than a single fund. That creates more opportunities to harvest losses. When we began using these strategies at Plancorp in 2017, the added cost limited when they made sense. Today, many of the SMA strategies we consider don’t cost much more than a rules-based ETF.
Long-short tax-managed accounts take the idea further. By using leverage to create long and short positions that may create more opportunities to realize capital losses while maintaining broad market exposure.
That adds real complexity, along with additional costs, tracking differences, shorting, and leverage. But for someone who knows a major taxable gain is coming, those tradeoffs may deserve consideration.
I will save the mechanics for a future episode.
Exchange Funds, Section 351 Exchanges, and Options for Concentrated Stock
The second problem was diversifying a concentrated position without immediately selling all of it.
An exchange fund may allow someone to contribute concentrated stock to a pooled portfolio and eventually receive diversified holdings. But it commonly involves a seven-year commitment and K-1 tax reporting.
In both conversations, an exchange fund looked potentially useful. But there was not enough capacity in a vehicle we were comfortable recommending.
A strategy’s existence does not mean a suitable implementation is available.
Depending on the holdings, a Section 351 exchange may allow a portfolio of appreciated securities to be contributed to a newly created ETF without triggering an immediate taxable sale. But the holdings must qualify, diversification rules must be satisfied, and not every offering is equally attractive.
Options provide another possible path. A collar can limit the downside on a stock position while also limiting some upside. Pairing a costless collar (buying a put and selling a call) with synthetic exposure (selling a put and buying a call) can then add broader market exposure elsewhere.
That sounds like a lot. That is partly the point.
Each approach solves the diversification problem differently. Each also comes with a different combination of taxes, costs, liquidity, upside, and implementation risk. The right comparison is not which one sounds most sophisticated. It is how each one stacks up against simply selling the stock, paying the tax, and diversifying.
GRATs and Estate Planning: When Complexity Can Create Value
The third group involved estate planning.
A grantor retained annuity trust, or GRAT, is not an investment strategy in quite the same sense. But it came up in one of my conversations as a good example of complexity potentially creating tremendous value. When structured and administered correctly, a GRAT may allow future appreciation to pass to beneficiaries very tax-efficiently.
The legal documents, asset selection, tax rules, and administration are complicated.
But something can be complicated to build and manage without making your life feel complicated. You don’t need to know how the inside of a watch works to know what time it is. But you should understand what the strategy is intended to accomplish, its major tradeoffs, and who is responsible for making it work
Why Complex Investment Strategies Require Experience and Due Diligence
Complexity is not automatically valuable.
It can create higher fees, lockups, K-1s, leverage, tracking error, capped upside, implementation risk, and more opportunities for something to go wrong. It can hide bad economics just as easily as it can solve a real problem. That is why experience and due diligence matter.
Not every advisor has experience evaluating or implementing these strategies. Hearing the name of one is different from knowing who is a good fit, which providers to consider, how it interacts with the tax and estate plan, and when the simple answer is still better.
This is also where professional management may earn its fee. Paying someone merely to assemble low-cost funds is one thing. Paying someone to identify an opportunity, compare it with the simple baseline, evaluate providers, coordinate the moving pieces, and recognize when to walk away is a different service.
The two listeners I spoke with did not leave eager to add complexity everywhere. They remained cautious. But they could see why these strategies deserved consideration.
That was the right outcome.
I devote an entire bonus chapter of The Perfect Portfolio to tax-efficient diversification strategies like these. If there is one you would like me to explain in more detail on a future episode, reach out and let me know.
Simplicity is a virtue. But when it becomes an ideology, it can prevent you from solving the problems that matter most.
Start with the simple answer. Then make complexity earn its place.
Sometimes, it does.
The Long Term Investor audio is edited by the team at The Podcast Consultant
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Disclosure: This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.
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