For investors who are wealthyenough to meet the minimum investment thresholds, separately managed accounts offer several advantages over mutual funds, such as greater transparency, flexibility and the opportunity to harvest tax losses. However, despite the hoopla over tax management, financial advisors often see clients who claim they want SMAs for the tax benefits, but then fail to take full advantage of the chance to lighten Uncle Sam's wallet.

A significant portion of investors who use SMAs do so within an IRA or other tax-sheltered vehicle, which means that the potential tax savings specifically from the SMA never come into the picture. At New York-based Smith Barney, for example, that scenario accounts for about half the $189 billion assets under management in SMAs, according to Marc Bookman, a managing director responsible for product development and management. When clients open SMAs at Smith Barney, they can check a box to sign up for a special tax-management service, but Bookman says only 20% to 25% of clients do so. In effect, the majority of the people who use Smith Barney SMAs in a taxable environment do not give top priority to the tax benefits. "Certain people have more interest in tax management than others," Bookman says. "It's surprising. I always think the percentage should be higher."

The biggest potential tax benefit comes from the ability to manage the tax basis in a portfolio of individual securities. Investors can sell a stock that has lost value, wait the required 30 days to avoid a wash sale, and then repurchase the stock. The net result is a tax loss that can then be used to offset gains elsewhere in their portfolio, whether within the SMA or among other securities they own. Financial advisors can flag these opportunities, but clients have to pull the trigger—and all too often, they don't. Bookman points out that, like other brokerage firms, Smith Barney doesn't give tax advice, so each financial advisor needs to work with the client's tax professional, the SMA money manager and the advisor's own operations department to deliver the full tax benefits SMAs can offer.

But even with the help of a tax professional, the full advantages from an SMA can still fall by the wayside. Elizabeth Sadwick, senior vice president of marketing at Congress Asset Management, a Boston-based money manager that runs a $3.5 billion large-cap growth SMA program, says the financial advisors her firm works with usually do work with an accountant and a tax professional to customize the advice they give for a particular client's needs.

Still, Sadwick acknowledges that many clients do not get the full potential tax savings from their SMAs. She recommends that tax planning become a regular part of the investment process. "Having the discussion in December is not necessarily healthy for that fiscal year," she says.

Even people who are interested in principle may not realize the tax benefits in practice. "Investing is a very personal matter, especially direct ownership of stocks," Sadwick says. "When news comes out, clients will make decisions based on that versus the overall fundamentals or tax [implications]." And clients who have concentrated stock ownership in the companies they work for sometimes refuse to diversify, as well. Financial advisors have to assess whether clients who say they want the tax savings that SMAs offer will really be able to overcome any psychological baggage that gets in the way. "I don't think the hype about the tax benefits of SMAs is overdone," Sadwick says. "But more often than not, it is not executed upon because other things come into play for the client."

That doesn't mean SMAs are a bad idea, however. Sadwick notes that they still offer greater control and flexibility over assets than do mutual funds. With an SMA, a client gets a portfolio manager as well as a financial advisor—and both are working to meet the client's long-term financial needs and to ensure that assets are not depleted. "Tax considerations are usually secondary," Sadwick says. "Changes in market conditions, risk assessment, a client's need for income and peace of mind really drive what type of investment vehicle they use."

Congress Asset Management has a $500,000 minimum for SMAs so clients need to have at least another $2 million in investable assets to participate. "Congress only manages in one style mandate: growth," Sadwick says. "You still need international, value and so on."

Smith Barney's Bookman notes that, by their very nature, SMAs have another tax advantage over mutual funds, one that doesn't require client action. In SMAs, investors never inherit tax consequences from previous trades. Mutual fund investors, on the other hand, buy into an existing portfolio in which every security already has an established tax basis. The investor has no control over when the manager sells securities, which tax lots are sold, or when the fund distributes capital gains. "Whether you held the fund for the entire year, 10 years or one day, you own a proportionate share of the entire amount of every realized gain or loss," Bookman says. SMA investors are also protected against the behavior of others, whereas mutual fund investors may incur a tax liability if the manager has to liquidate positions to meet redemptions by fellow shareholders.