Your Investments: Cleaning up an inherited portfolio

“If it was good enough for my father, it’s good enough for me.” I can’t tell you how often I hear that line when speaking with someone who has received an inheritance.

Children often refuse to make changes to a portfolio that they received as an inheritance. Very often, this is due to sentimental reasons; the last connection that they have to the deceased. Sometimes it’s a feeling that since the parent left the child so much money, they must have known what they were doing vis-à-vis investing – so, who is the child to make any changes? When a new client who received an inheritance seven years ago opened up an account with me, we sat down to review his current holdings and discus the portfolio. Some of the client’s stocks were showing large losses. It turns out that the parent had decided to move a big chunk of his portfolio into bank stocks back in 2003.

The child received the inheritance after the father’s passing in 2005, but felt that he shouldn’t make any changes to the portfolio. Fast forward to 2012 and many of those bank stocks are trading at a fraction of what they were seven years ago.

I asked him why he never made any changes to the portfolio and he explained that since he had received them as an inheritance, he felt awkward about selling them. He felt a certain attachment to them and didn’t think they should be sold. He then admitted that such emotions were not a great way to base investments, and he decided to wait for them to move back up to the price for which his deceased father had bought them.

Then, he would sell them.

Needless to say, he may be in store for a very long wait.

You are not 90

In addition to the previous case, another common scenario is someone receives an inherited portfolio where the investments are geared for someone who is living off fixed income, or is wealthy enough that certain investments are made for tax-efficiency reasons.

I sat with someone in his late 20’s who received a substantial amount of money from his grandmother who recently passed away. She was in her mid 90’s and her portfolio was invested solely in tax-free municipal bond mutual funds, and Israel bonds.

Now, that happened to be a smart investment approach for her, but her twenty-something grandson, who is in university getting an advanced degree, has no real need for tax-free income because he has no income to speak of and therefore doesn’t pay any taxes.

He also has little need for Israel bonds that pay virtually zero interest and provide no capital appreciation.

After all she bought the bonds to support Israel; he lives in Israel. He has his whole life ahead of him and the portfolio should match his goals and needs, not his grandmother’s, now that it’s his money.

Start fresh

Due to tax rules, individuals who receive an inherited portfolio are able to sell what’s in it and start from scratch. This is because of what’s known as a “step-up” in cost basis.

Amy Feldman, in a Reuters “Money” article explains, “Typically, if you sell a financial asset at a gain, you’ll owe capital gains tax on the amount you made; the current rate on long-term gains is 15%. But if you’ve inherited assets, you get to take advantage of what’s known as the ‘step-up in basis.’ “That means that the ‘basis’ of whatever you’ve inherited [that is, the amount at which it’s valued for tax purposes] resets on the date you received it. The result is that if you sell, you won’t owe any taxes on the gains that may have built up over years, or decades, of ownership before you inherited it.”

This gives you the ability to figure out your goals and then create a portfolio that fits your investment profile.

Feldman quotes Scott Hanson, a senior partner and founding principal of Hanson McClain, a Sacramento-based financial advisory firm, with $1.3 billion under management who says, “When you inherit assets, it’s a good time to be selling things. You’ve got a fantastic opportunity to liquidate the portfolio, avoid any taxes, and build it back as you want.”

There is a good chance that the relative that left money for you as an inheritance would like you to gain from it. Speak with your financial adviser to see if your inherited portfolio matches your investment goals and whether it is invested in an efficient manner.

aaron@lighthousecapital.co.il Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.