296 | Understanding Leverage, Short Selling, and Active Trading in Tax-Aware Long-Short Strategies (Part 2 of 2)

[00:00:34] Hilary Hendershott: Well, hey, Money Lover – as you know, I’m Hilary Hendershott, CFP^® and founder of Hendershott Wealth Management^®. For over 25 years, I’ve helped high-net-worth investors grow and keep more of their wealth with practices grounded in evidence, integrity, and proactive tax strategy.

[00:00:52] In our last episode, I shared a portion of the audio from the 7-part video series I recorded about how a few relatively common investment tools you’ve been taught to fear—like leverage, short selling, and active trading–come together in our tax-aware long-short strategy to create tax alpha. Tax alpha means higher net returns that don’t come from investment performance, but from smart tax strategy.

[00:01:20] And, how this strategy can make a 7- or even 8-figure difference for suitable investors, which means millions, or even tens of millions of dollars in additional wealth.

[00:01:30] If you haven’t listened to part one yet, go back and start there. Today, I’m sharing part two, which covers the last two videos in our 7-video series. If you prefer to watch, head over to our YouTube channel at youtube.com/@hendershottwealth where you can find the entire series.

[00:01:49] Now, before we go any further, I do want to mention that my team does not prepare taxes–and the clients with whom we use the strategies inside our Ultra Tax Efficient Wealth Management℠ suite do need to have a professional tax preparer–that’s a CPA or an EA. We collaborate with that professional to make sure the tax-aware planning we do from our side is incorporated into our clients’ returns.

[00:02:11] Alright, if you listened to part one of the audio from this series here on Love, your Money^® where I explained the use of leverage and short selling in the tax-aware long-short strategy we use in our UTEWM℠ suite of services, you might’ve been left wondering:

• “Wait—doesn’t this involve a lot of trading?
• Isn’t that market timing?
• And haven’t I heard a thousand times–from YOU, Hilary–that market timing almost always underperforms index funds?”

[00:02:38] I’m glad you asked, and it’s true. Active trading has a bad reputation—and, for the most part, it deserves that bad reputation.

[00:02:46] But the active trading that happens within the tax-aware long-short strategy isn’t about chasing headlines, jumping in and out of the market, or making bets based on guesses or gut feelings.

[00:02:57] In this case, it’s a systematic, rules-based strategy to produce a small amount of excess return and make the tax code work in your favor–without altering your long-term investment plan.

[00:03:09] In this episode, I’ll break down what active really means in this context, and I’ll walk you through how the tax-aware long-short strategy works—from the ground up—so you can understand why we consider it the most powerful tool in our UTEWM℠ suite in many cases.

[00:03:26] There’s a key distinction between traditional active trading and how it’s used in tax-aware long-short investing, and it has to do with the intended result the investment manager wants to produce.

[00:03:38] Traditionally, active trading is about chasing large potential returns by trying to time the market, predicting what will go up or down next—and when.

[00:03:48] It’s reactionary, it can be very emotional, and it can lead to buying high and selling low.

[00:03:54] In contrast, the long-short overlay used in tax-aware long-short is systematic. It’s a disciplined, evidence-based overlay that follows a set of consistent, rules-based algorithms that have been built on decades of academic research.

[00:04:11] And while yes, it involves regular trading, the strategy is not solely focused on “beating the market.” It’s engineering portfolios to do a few things:

• It creates more opportunities to harvest losses to lower your tax bill,
• It does not sacrifice liquidity or add market risk, and
• It leaves your core investment strategy–and the returns it produces–fully intact

[00:04:35] So, while active trades are happening, the intention is not to outguess the market. The intention is to optimize when and how much taxes you pay–following the IRS’s own rules.

[00:04:50] There’s no predictions–only the strategic production of tax alpha: higher net returns that don’t come from investment performance, but from smart tax strategy.

[00:05:01] Here’s what’s going on behind the scenes inside the tax-aware long-short strategy we deploy using AQR Capital Management’s Flex SMA product. There are three components to the foundational approach:

1. [00:05:16] The core portfolio. This is your globally diversified, long-only portfolio. It’s low-cost, it’s passive, and it’s built for growth. We use this as collateral—not to gamble, but to unlock opportunity.

1. [00:05:30] The long overlay. We borrow at a low cost and invest in more diversified positions. That boosts the size and number of positions in your portfolio, creating more opportunities for both returns and harvestable losses. But borrowing creates downside risk, which is inoculated against by the third piece…

1. [00:05:52] The short overlay. This is the safety mechanism. We sell stocks we don’t own—by borrowing them from the custodian and selling them (and eventually repurchasing them later to return to the original owner). If markets fall, these short positions make money—which offsets the extra losses from the expanded long overlay.

[00:06:15] Together, the long and short overlays create tax losses, whether the market is up or down, without generating portfolio losses because one is always doing well and the other is not. This is your tax alpha.

[00:06:29] The magic isn’t in trying to win on either side. It’s working with the naturally occurring ups and downs of the market, creating consistent, tax-advantaged losses across the long and  short positions while keeping your investment exposure stable.

[00:06:43] Again–it’s not guessing. It’s strategic management, where:

• The system identifies hundreds of long and short stock positions
• Trades are executed regularly, based on rules—not opinions or speculation
• It’s fully diversified, so no single position can sink the strategy
• And it’s market neutral, meaning your total risk exposure stays the same

[00:07:06] Even when markets are up, the strategy finds opportunities to realize losses in the short overlay, which offset taxable gains in your core portfolio. When markets are down, we are harvesting losses from that long overlay.

[00:07:20] So, that’s what makes this so effective in achieving tax alpha: You keep your market returns–and sometimes even net higher ones–but reduce your tax burden.

[00:07:31] You don’t need to be a tax strategist or portfolio engineer to benefit from this strategy–that’s what we’re here for. Our team and the Flex separate account managers handle it all on your behalf.

[00:07:43] What’s the result? You stay invested and you keep growing your wealth, but you dramatically reduce how much of it goes to the IRS.

[00:07:51] Let me be crystal clear: This isn’t something we stumbled into. As fiduciaries, we’re legally and ethically obligated to act in your best interest and we always do our due diligence–in this case, months of it.

[00:08:04] Before adding the Flex SMA tax-aware long-short strategy to our UTEWM℠ suite, our team went heads-down in due diligence mode, including:

• A thorough vetting of the custodian, Fidelity–and probably Charles Schwab in the near-term future–and investment manager, AQR Capital Management,
• We evaluated the strategy’s track record,
• We independently confirmed the strategy’s efficacy,
• We quantified the strategy’s risk,
• We verified account holders’ access to their capital
• And, most importantly, we affirmed that it will help real people like you reduce their tax bill without sacrificing performance or risk.

[00:08:46] The conclusion? This strategy is not built for everyone. But for suitable clients—those with $1.25 million or more in taxable assets—tax-aware long-short investing makes a meaningful, measurable difference over time, potentially increasing your lifetime wealth by 30-50%.

[00:09:04] And it’s aligned with the same evidence-based, long-term approach we’ve always believed in.

[00:09:10] So is this active trading? Technically, yes. But in spirit? No—because it’s not about market timing.

[00:09:17] It’s thoughtful, engineered tax efficacy. It’s staying invested while minimizing what you owe Uncle Sam. And, in many cases I see, it’s one of the most powerful upgrades we’ve ever offered our clients.

[00:09:32] Alright, at this point–if you already listened to part one of this audio–you now understand the mechanics behind the keystone offering inside UTEWM℠—the tax-aware long-short strategy we offer via AQR’s Flex SMA–and how the strategy uses carefully constructed overlays to generate consistent tax advantages.

[00:09:53] You’ve learned:

• What financial leverage is, and what makes it low or high risk
• Why market-neutral strategies are different than risky bets
• And how thoughtful design can help you reduce capital gains taxes while staying fully invested

[00:10:07] If you haven’t listened to part one of the audio here on the podcast feed or watched the first 6 videos in this series yet over on YouTube, make sure you go back and start there.

[00:10:18] Now, we’re going to bring together everything we’ve covered so far and connect the dots to why it matters–and why it matters now. Because here’s the truth:

[00:10:26] Smart, ethical tax planning allows you to keep more of your money, without needing to take unnecessary risk or compromise your growth.

[00:10:36] The tax alpha we’ve talked about achieving isn’t just about returns. It’s about freedom. It’s about choices. It’s about keeping more of what you earn—so you can use your wealth to create the life you actually want.

[00:10:49] So let’s zoom out and talk about who this strategy is really for—and what it makes possible.

[00:10:54] For many high-net-worth investors, taxes are your largest lifetime expense.

[00:11:00] And for decades, the default strategy has been to pay them when they’re due—and move on. But for every dollar paid in taxes, that’s one less dollar compounding for future growth, and it’s one less dollar you’ll ever get to spend. It’s painful, when you think about it.

[00:11:16] Of course, investors had limited options for mitigating those tax bills, and in fact, I’ve witnessed people who are eager to avoid taxes make some seriously questionable financial moves in the name of tax efficiency. From risky alternative investments and exchange or swap funds to the alphabet soup of potentially disallowable trusts like CRATs, CRUTs, GRATs, and IDGTs… the list goes on.

[00:11:42] To their credit, they’ve just been taking advantage of the (frankly) underwhelming set of tools that have been available to them–but what it’s really doing is introducing unnecessary complexity, potentially risking an audit, and by no means contributing to a positive impact on their financial future.

[00:11:59] But what if you could do better than that?

• What if you could diversify a concentrated stock position without a 7-figure tax bill?
• What if you could sell your primary residence, a business, or other illiquid assets—without the capital gains taxes erasing years of growth?
• What if you could spend freely in retirement, fund your kids’ future, or give to causes you care about, without wondering how much you’ll owe at tax time or spending down your portfolio?

[00:12:28] And what if you could do it all without compromising your core portfolio and introducing unnecessary risk?

[00:12:33] That’s what we make possible with the strategies in our Ultra Tax Efficient Wealth Management℠ suite of services.

[00:12:40] Not through sleight of hand or hiding from the IRS—but through intelligent planning, advanced tools, and proactive wealth management.

[00:12:49] Ultra Tax Efficient Wealth Management℠ is not a single product—it’s an integrated, multi-layered suite of services.

[00:12:56] Think of it like the financial equivalent of a specialized team of doctors working on a complex diagnosis: proactively working across disciplines to customize a plan to keep your wealth strong, flexible, and protected from unnecessary tax erosion.

[00:13:13] Here’s a very simplified summary of what we do within UTEWM℠:

• We offer Annual Tax Letters & Tax Return Reviews to look for costly errors and keep your tax team aligned
• We offer Smart Asset Location, so each investment is placed in the most tax-efficient account
• We offer Tax-Aware Investment Selection, including ETFs, tax-managed mutual funds, and ongoing tax-loss harvesting
• We offer Equity Compensation & IPO Planning to reduce taxes and increase value on stock-based compensation, as well as
• A Contribution Strategy to help you max out every legal opportunity to defer taxable income and reduce taxes now

[00:14:00] And while we use UTEWM℠ strategies for all our clients, in many of the cases we’ve seen, the Flex SMA tax-aware long-short strategy that we’ve based this series on is the most powerful strategy available for suitable investors who are intentional about minimizing capital gains taxes and maximizing their wealth.

[00:14:23] You’ve worked hard. You’ve made smart decisions. You’ve taken some risks that paid off.

[00:14:29] Now, you want to protect and preserve the wealth you’ve built—not just for yourself, but for your family, and your legacy.

[00:14:37] You want clarity, efficiency, and elegance—not unnecessary cost and complexity.

[00:14:43] You want to work with a team that gets it—that understands your goals, sees the full picture, and has the tools and discipline to help you grow what you’ve built.

[00:14:55] To be a suitable investor for Flex SMA:

• You have $1.25 million or more in taxable assets
• You’ve accumulated (or expect to have) significant capital gains— whether that’s in your portfolio, your real estate, business equity, or company stock, and
• You’re looking for ways to reduce your tax bill without taking unnecessary risk

[00:15:18] So if that’s you–or someone you know–keep watching because this is a conversation you want to be a part of.

[00:15:25] Capital gains taxes are not going away. In fact, there’s a real possibility they’ll increase.

[00:15:30] For suitable investors with meaningful wealth in taxable accounts, waiting to make a plan to diversify concentrated or appreciated stock, offload real estate, or sell a business can cost hundreds of thousands—or even millions—over time.

[00:15:46] Tax-aware investing isn’t a fad. It’s the present and it’s the future.

[00:15:51] It’s what makes it possible for an investor with a $12M concentrated stock portfolio to diversify their holdings in just two years–without the $4m tax bill.

[00:16:03] It’s what allows for a retired couple to save $1.6M in taxes during retirement and direct that money to their kids rather than the IRS.

[00:16:12] It’s what allows for a 38-year-old startup employee to take her $9M IPO windfall, defer paying capital gains taxes on it, and turn it into $20M by age 65,

[00:16:27] And, more generally, it’s what allows you to keep your options open, stay flexible in uncertain markets, and confidently say yes to the life you’re working so hard to create.

[00:16:40] Our Ultra Tax Efficient Wealth Management℠ offer–including Flex SMA–is not a product. It’s a philosophy. It’s a suite of services working in harmony. And for many affluent investors, the Flex SMA is one of its most impactful tools.

[00:16:58] The earlier you start increasing your tax efficiency, the more you can save—not just in compounding dollars, but in stress, limitations, and lost opportunities.

[00:17:09] At Hendershott Wealth Management, our goal is simple: to help you keep more of your money, and use it in ways that matter–because we want you to thrive.

[00:17:18] You’ve built your wealth with intention. Let’s manage it that way, too.

[00:17:23] Over the past 25 years, I’ve seen how fear of taxes quietly drives financial decisions–and I’d never encountered a truly effective, long-term tax mitigation strategy–until recently with Flex.

[00:17:36] What I had seen was people contorting their lives around avoiding paying capital gains taxes–at the cost of their quality of life.

[00:17:47] I’ve watched people accumulate $10, $20 million appreciated stock portfolios, delay succession plans in business, or hold onto property they no longer want, only to feel stuck.

[00:17:59] They don’t want to sell, even if it’s the best move for their life, because they’re terrified of the tax bill.

[00:18:05] They end up with no clear exit plan, and miss out on the freedom their wealth should provide.

[00:18:11] That’s not tax strategy, that’s tax avoidance–and it has always felt out of alignment to me. If you’re going to have a $20 million portfolio, you should be living like royalty.

[00:18:22] And with the right strategy, your money can support your vision—without fear, without waste, and without regret.

[00:18:29] If you’re ready to see how the strategies inside our Ultra Tax Efficient Wealth Management℠ suite of services can help you keep more of what you earned–and whether the Flex SMA long-short strategy belongs in your wealth plan–head to hendershottwealth.com/contact.

[00:18:46] You’ll get paired with one of our lead advisors for a complimentary Discover Call up to 45 minutes long.

[00:18:53] We’ll take a look at your financial picture, help you assess your current tax drag, and figure out if implementing a tax-aware long-short strategy is a smart next step for you.

[00:19:05] If it’s not, we’ll point you in the right direction. But if it is—it could make a seven- or even eight-figure difference over your lifetime.

[00:19:13] Either way, you’ll walk away from our call with clarity, insight, and a better understanding of how to make your wealth work harder—and smarter—for you.

[00:19:23] Thanks for joining me for this series–and thank yourself for taking your financial future seriously—because smart money decisions don’t just build generational wealth, they create lifelong freedom.