The 4 Tiers of Tax Smart Investing

It’s a beautiful chilly winter day today and today instead of diving into a specific tax saving strategy, I’d like to share with you a framework that you can apply to help you pay less in taxes.

For any of you who’ve met with you before, you’ve probably heard me talk about how Robert Kiyosaki’s “Cash Flow Quadrant” teaches us one of the keys to paying less in taxes.

Effectively, you must become a business owner and investor in order to significantly lower your tax bill.

That’s good to know, but once we know what to do, it can be hard to know how to do.

For example, in this case, it’s good to know that we need to become business owners and investors to lower our tax bills, but how do we invest to lower our tax bill?

Well today’s framework will start to teach you how to invest like a tax-smart investor.

Let’s dive right in.

The 4 Tier Investment Framework

Now this framework isn’t something you’ll come across just any day.

I first began to become aware of this framework during my first stint at EY.

I noticed that many of my very wealthy clients did not invest the same way that many of my other friends and family members invested. 

So I began to ask questions, listened to their stories, and researched the various things they were doing.

Over the next few years I began to see a pattern and as this pattern solidified, I created my “4 Tier Investment” framework.

What I saw was that those who seem to create the most wealth and do so without creating huge tax bills for themselves generally made four types of investments:

• Market based growth investments

• Cash flow focused investments

• Alternative investments

• Moonshot investments

Let’s walk through each of these tiers of investments and I’ll give you examples of the types of investments and the tax strategies that accompany each type of investment.

Tier 1 - Market Based Growth Investments

These are the investments that most individuals are most familiar with and likely feel the most comfortable with themselves. Typically these investments are optimized for long-term growth while simultaneously trying to avoid unnecessary losses.

A few examples of these types of investments would be stock market based…

• Mutuals funds

• ETFs

• Company stock compensation

• And other individual securities

Some of the associated tax saving strategies include:

• Tax loss harvesting

• Qualified dividends

• 83(b) elections

• Roth conversions

• And more

Tier 2 - Cash Flow Focused Investments

Most individuals have some exposure, even if not much experience, with many of the investments that you’ll find in this tier. Typically these investments are optimized to create cash flow that you won’t outlive and provide you the financial freedom you desire.

A few examples of these types of investments would be…

• Dividend and interest focused stock market investment strategies

• Cash flowing real estate

• Hard money loans

• Fixed indexed annuities

• “Lifestyle” businesses

Some of the associated tax saving strategies include:

• Municipal bonds

• 1031 exchanges

• S-Corp elections

• And more

Tier 3 - Alternative Investments

Tier 3 is where we start to find investments that the average person likely has never considered investing into, but there can be some cross over from Tier 2 if it’s designed to create tax benefits. Typically these investments are optimized to create both cash flow and tax benefits.

A few examples of these types of investments would be…

• Private Equity (real estate, business, etc.)

• Hedge Funds

• Angel Investing

• MLPs

Some of the associated tax saving strategies include:

• Entity and structure planning

• Cost segregation studies

• QSBS

• Conversion provisions

• And more

Tier 4 - Moonshot Investments

When considering this tier, think of Shark Tank: you don’t put a huge amount into them, but you’re making bets that could pay off big. But it doesn’t have to just be investments in companies, it could be a number of things. Typically these investments are optimized to create outsized returns.

A few examples of these types of investments would be…

• Your buddy’s new business idea

• Collectibles (baseball cards, specialty cars, etc.)

• Art

• Bitcoin (I know you may disagree but we can debate this online)

As for the tax strategies that you’d use with these investments, well, many of the strategies listed above could be used with these as well.

Why should this matter?

This is one framework that you can use to help you begin to become more tax efficient with your investments and drive down your tax rate over time.

For example, if you look at this framework and think to yourself, “Shoot, I really only hold Tier 1 investments!”, then it’s time to start exploring the other tiers and choosing one or two investments to make in the coming year.

If you look at the tiers and feel like you have some investments in most of the tiers but you’re not getting the tax outcome you’re hoping for, then it's time to review your investments and adjust to ensure they are properly optimized according to the associated tier.

Conclusion

This framework can be a helpful tool, but it’s just that: a helpful tool.

Make sure you take the tool and put it to use. Like all things in life, it’s only through action that we can begin to make real progress in our financial life and with our taxes.

For those of you that have read to this point, I’d love to know what it is you like or disliked about this framework. Hit Reply and let me know your thoughts.

Thanks as always for your time and remember, success leaves clues and Contenders are always wanted.