The Case for Building an Individual Stock Portfolio in a Taxable Investment Account
The Case for Building an Individual Stock Portfolio in a Taxable Investment Account
Exchange traded funds and mutual funds provide a very effective and simple way to invest and diversify in a single product. Even as little as a few funds can provide sufficient diversification for many portfolios.
But if you’re looking for a more strategic approach that carries potentially significant tax savings, there’s a strong argument to be made for building an individual stock portfolio instead.
With individual stocks, you’ll have far more control over when you realize gains and losses. That control can translate into meaningful tax savings over time, making individual stock portfolios a powerful wealth-building tool.
Let’s break down the advantages.
Funds vs. Stocks: What’s the Difference in a Taxable Account?
Funds pool together dozens—or sometimes hundreds—of securities. When you buy shares of a fund, you own a slice of the entire basket. It’s simple, efficient and provides diversification; but it comes with a catch in a taxable account: you don’t control the fund’s trading activity.
If the fund manager sells a stock at a gain, that gain gets distributed to shareholders—even if you personally never sold a share. This means you could owe taxes for activity you didn’t choose and might not benefit from directly.
This downside is mitigated by using Exchange Traded Funds (ETF’s)instead of mutual funds, which in most cases, produce less or no capital gain distributions. However, even though ETF’s may not produce an annual capital gain distribution, it’s still accruing a large unrealized gain (assuming it’s growing), that at some point in the future, you’ll have to begin selling if you want or need access to that money.
With an individual stock portfolio, on the other hand, you can keep the overall unrealized gains in the account low year after year, despite the portfolio increasing in value. This is possible through tax loss harvesting.
Tax-Loss Harvesting: Balancing Gains with Losses
At the heart of the case for individual stock portfolios is the ability to offset taxable gains with losses. Here’s how it works:
If you sell a stock at a profit, that’s a capital gain, which is taxable.
If you sell another stock at a loss, that’s a capital loss, which can offset the gain.
In practice, nearly every stock portfolio will have both winners and losers at any given time. With an individual stock strategy, you can use the losers strategically to cancel out the tax impact of the winners. This cannot be done using funds.
Let’s illustrate how this works:
Hypothetically, if one investor, Jeremy, invests $500,000 into the US Equity markets using ETF’s, and after 10 years his portfolio has grown to $1,000,000, he has $500,000 of unrealized gains. Eventually, when he retires, he’ll need access to that money and will have to start selling some of those ETF’s, causing realized gains each year he does so, which will eat into his profits.
On the other hand, Lauren also invested $500,000 into US Equities, but chose to build a well-diversified portfolio of several dozen individual stocks. Because her stocks were carefully picked to ensure broad diversification across sectors and company sizes, her overall return was roughly the same as Jeremy’s. However, when her portfolio reaches $1,000,000, she has significantly less unrealized gains than Jeremy does.
She used tax loss harvesting along the way, while Jeremy could not do so. Even though Jeremy’s portfolio contained stocks that dropped in price, he wasn’t actually able to sell those stocks and take advantage of that loss, because those stocks were held within the ETF.
Additional Benefits Beyond Taxes
While the tax control is often the biggest selling point, there are other advantages to building a stock portfolio in a taxable account:
Transparency – You know exactly what you own, rather than being subject to hidden turnover within a fund
Customization – You can align your holdings with your values (e.g., avoiding certain industries) or concentrate in areas you have conviction in.
Downsides to This Strategy:
Complexity: Managing dozens of stocks requires more monitoring and decision-making than owning mutual funds or exchange traded funds
Behavioral Risk: Some investors are tempted to trade too frequently, chasing short-term performance rather than sticking with a disciplined strategy
Diversification Risk: If not carefully built, an individual stock portfolio can end up overweight in certain sectors, potentially increasing risk, or limiting returns.
That said, for investors with meaningful taxable assets, the potential tax savings often outweigh these concerns—especially when the portfolio is designed and monitored with professional guidance.
Who Should Consider This Strategy?
An individual stock portfolio in a taxable account is often best suited for:
High-net-worth investors who face significant capital gains taxes.
Tax-sensitive investors who want to manage their yearly tax liability actively.
Long-term investors who can hold through volatility but still want to harvest losses along the way.
Main Takeaway:
Funds remain an excellent tool for many investors, and are often ideal for retirement accounts where gains and losses along the way are irrelevant from a tax perspective.
But for taxable investment accounts, tax loss harvesting is a crucial tool to manage the taxable gains while seeking growth over time. Using individual stocks is one way to leverage this tool to your advantage. In most cases, a combination of funds and individual stocks in a single portfolio can give the best of both worlds.
As stated earlier though, this strategy is far more time consuming. Not only do you need to research the companies you may invest in, but you also need to research the overall portfolio to ensure it has adequate diversification across sectors and company size.
If you have an investment account that you think may have room for improvement from a tax efficiency perspective, reach out to me or our team and I’ll provide a complimentary review of your portfolio.
Ryan Page, CFP®, MBA®
Office & Text:720-826-1092
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Stock investing includes risks, including fluctuating prices and loss of principal.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
