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If you're a high-net-worth family still holding the bulk of your investments in mutual funds, you might be leaving serious money on the table: and not in the way you'd expect. The culprit isn't poor performance. It's taxes.

Over the past few years, we've seen a significant shift among affluent families moving away from traditional mutual funds and into Separately Managed Accounts (SMAs). The reason? Superior tax efficiency that can translate into hundreds of thousands of dollars saved over time.

Let's break down exactly why this migration is happening and whether it makes sense for your family's wealth.

The Great Migration: Why the Shift is Happening Now

Here's the reality: mutual funds were designed for mass-market investing. They pool money from thousands of investors, and everyone gets the same tax treatment: whether it benefits them or not.

For families with portfolios under $500,000, that trade-off often makes sense. The simplicity and lower minimums of mutual funds are worth the tax inefficiency.

But once your investable assets climb past six or seven figures? The math starts working against you. High-net-worth families are realizing that the tax drag from mutual funds can cost them 1% to 2% of their portfolio annually: money that compounds against you year after year.

That's why more families are exploring sophisticated wealth management strategies that prioritize after-tax returns over headline performance numbers.

Illustration of a wealthy family's investment path splitting between mutual funds and SMAs for tax efficiency

SMAs vs. Mutual Funds: A Quick Breakdown

Before we dive into the tax benefits, let's make sure we're on the same page about what each vehicle actually is.

Mutual Funds: You buy shares of a fund that owns a basket of securities. You don't own the individual stocks or bonds: you own a piece of the fund. Every investor in that fund shares the same cost basis and receives the same capital gains distributions.

Separately Managed Accounts (SMAs): You directly own the individual securities in your account. A professional manager makes investment decisions on your behalf, but the stocks and bonds are held in your name with your own cost basis for each position.

This distinction might seem minor on the surface, but it has massive implications for how your investments are taxed.

The Tax Efficiency Advantage That's Driving the Switch

Let's get into the specifics of why SMAs offer such compelling tax advantages for HNW families.

Individual Cost Basis and Loss Harvesting

In an SMA, each security you own has its own cost basis. This means your manager can make specific, tax-motivated decisions that are simply impossible with a mutual fund.

The big one? Tax-loss harvesting.

Your SMA manager can strategically sell positions that have declined in value to realize losses. These losses can then offset capital gains within your portfolio: or gains from other sources like real estate sales, business income, or private investments.

This isn't a one-time benefit. With daily security-level tax-loss harvesting (something we discuss regularly on the 1715 Podcast), you can systematically capture losses throughout the year while maintaining your target asset allocation.

Mutual funds can't do this at the individual investor level. Everyone in the fund gets the same treatment, regardless of their personal tax situation.

Avoiding Unintended Tax Distributions

Here's something that catches a lot of mutual fund investors off guard: you can owe taxes on gains you never actually received.

When other investors in your mutual fund redeem their shares, the fund manager may need to sell securities to meet those redemptions. If those securities have appreciated, the fund realizes a capital gain: and that gain gets distributed to all remaining shareholders, including you.

You could buy a mutual fund in November, receive a capital gains distribution in December, and owe taxes on gains that accumulated long before you owned a single share. It happens more often than you'd think.

SMAs eliminate this problem entirely. Because there are no other investors in your account, you're never forced to recognize gains from someone else's actions.

Hourglass showing tax documents turning into stacked gold coins, symbolizing tax-efficient investing

Customization That Reduces Tax Drag

SMAs offer a level of customization that goes beyond simple security selection.

Already own concentrated stock? If you received company stock through equity compensation, you can instruct your SMA manager to exclude additional shares of that company from your portfolio. This manages concentration risk without triggering a taxable event.

Funding flexibility: You can transfer existing securities into an SMA without selling them first. With a mutual fund, you typically need to contribute cash: which may force you to sell appreciated positions elsewhere and realize gains.

Coordinated tax planning: Your SMA manager can coordinate specific security sales with your overall financial plan, timing gains and losses to align with your tax situation each year.

These aren't minor tweaks. For families with complex financial situations: multiple income sources, equity compensation, real estate holdings, business interests: this level of control can meaningfully improve after-tax wealth accumulation.

Cost Considerations: When SMAs Make Financial Sense

Let's address the elephant in the room: SMAs typically cost more than mutual funds.

The average SMA charges around 1.34% of assets under management, though pricing often becomes more favorable for larger accounts. Most SMAs also require minimum investments of $100,000 or more, with many quality managers setting minimums at $250,000 or higher.

Mutual funds, by contrast, might charge 0.5% to 1% (or even less for index funds), with much lower or no minimums.

So when does the math favor SMAs?

The breakeven analysis typically works like this: If tax-loss harvesting and distribution avoidance save you 0.5% to 1.5% annually in tax drag (a reasonable estimate for actively managed mutual funds), and you're paying an additional 0.5% for SMA management, you're still coming out ahead on an after-tax basis.

For families with portfolios exceeding $1 million, the tax savings often justify: and exceed: the additional cost. For portfolios in the ultra-high-net-worth range, the difference can be substantial.

Aerial view of customizable vs. uniform investment models comparing SMAs and mutual funds for HNW families

Who Should Consider Making the Switch?

SMAs aren't the right fit for everyone. But you should seriously consider them if:

  • Your investable assets exceed $500,000 (and especially if they exceed $1 million)
  • You're in a high tax bracket where capital gains rates significantly impact your wealth
  • You have concentrated stock positions from equity compensation or business sales
  • You have gains elsewhere (real estate, business sales, private investments) that could be offset with harvested losses
  • You value transparency and want to see exactly what you own at all times
  • You're planning for estate transfers and want to optimize cost basis step-up strategies

If several of these apply to your situation, mutual funds may be costing you more than you realize.

How Davies Wealth Management Approaches SMAs

At Davies Wealth Management, we take a comprehensive approach to tax-efficient investing that goes beyond simply recommending SMAs.

We start by understanding your complete financial picture: income sources, existing holdings, estate planning goals, and tax situation. From there, we can determine whether SMAs, mutual funds, ETFs, or a combination makes the most sense for your specific circumstances.

For clients where SMAs are appropriate, we implement systematic tax-loss harvesting at the security level, coordinate with your tax advisors, and ensure your investment strategy aligns with your broader wealth plan: including estate planning considerations that many families overlook.

The goal isn't just to maximize pre-tax returns. It's to maximize what you and your family actually keep.

Taking the Next Step

If you've been investing primarily through mutual funds and your wealth has grown significantly, it's worth having a conversation about whether your current structure is still serving you.

The tax efficiency gap between SMAs and mutual funds compounds over time. A 1% annual difference might not seem dramatic in year one, but over a 20-year time horizon, that difference can represent a meaningful portion of your wealth.

Want to explore whether SMAs make sense for your family? Reach out to Davies Wealth Management for a portfolio review that examines your current tax efficiency and identifies potential opportunities. And for more insights on sophisticated wealth strategies, tune into the 1715 Podcast where we regularly discuss topics just like this.

Your portfolio's headline return is only part of the story. What matters is what you keep.