In this fast-paced global economy and complex tax system, professional advice is almost always worth the cost.
As 2017 lurches toward its end, investors need to plan their tax and investment moves before it’s too late. But it’s just as important to not do one thing.
Don’t make this tax mistake. Don’t buy a mutual fund that will soon make a large distribution. You may give the IRS a big gift.
Given the multi-year bull market, some stock funds will have large year-end capital gain distributions — sometimes 20% or more which could kick you into a higher tax bracket.
You can usually find out the size and timing of year-end fund distributions on the web. If you like a certain fund, wait until after the record date to buy shares. Only people who own shares as of the record date will get the distribution.
If you already own a fund that’s about to make a big distribution, you can still take action. If you don’t have a substantial unrealized gain in the fund, you can sell it before the record date. After the sale, you can use the proceeds to buy an index fund that’s similar to the fund you’ve sold. This ensures you’ll remain fully invested in that asset class.
If you have a big unrealized gain and selling the fund would result in a tax hit, there’s still one thing you can do. You can give some or all of your shares to charity before the record date. You’ll secure a tax deduction, avoid ever realizing the gain, and also avoid the current year income from the distribution.
Rebalance your portfolio by year-end. If you don’t review and rebalance your portfolio often, you’ll be over-allocated to assets that have done well recently (such as US equities) and under-allocated to investments that have performed relatively poorly. But asset classes tend to revert to the mean over long holding periods. Yesterday’s losers will eventually become tomorrow’s winners and past winners will decline.
If you sell your recent winners and buy more recent losers, over time rebalancing will lead to superior long-term results.
Rebalancing is the opposite of a market timing strategy.
You are selling high and buying low. You probably won’t do it exactly at the top or bottom, but that’s not the point.
Stick to your long-term asset allocation and investment strategy through up and down markets and do not let recent performance influence your long-term asset allocation. By regularly rebalancing you are controlling risk and ensuring your portfolio maintains its overall target asset allocation. You’ll stay on track to achieve your target return while taking an acceptable level of risk.
Rebalancing need not trigger taxes. Many people can maintain their asset allocation just by rebalancing assets held in retirement plans.
Avoid long-term and junk bond funds. Take a close look at your fixed-income portfolio and its interest-rate sensitivity. Many investors have bought risky and longer-term bonds to get a higher yield. With the Fed holding interest rates down for so long, that’s been the only way investors could achieve a decent yield.
However, as interest rates start to rise, longer-term bonds will get hit the hardest because bond prices move inversely with interest rates. High-quality, short-term bond funds may seem boring, but they’ll seem pretty exciting when rates rise and long-term bond funds start falling.
Lower your investment costs. While you’re rebalancing, revisit the universe of mutual funds and ETFs to ensure you are using the most cost-efficient funds available. Sometimes mutual funds create new share classes, which may have a lower expense ratio.
You may also find a similar fund or ETF with basically the same market exposure but much lower expenses.
But be mindful of the trading costs and possible tax costs to switching out an investment. It doesn't always make sense to trigger commissions and taxable gains just to save a few basis points of expense ratio.
Consider the tax efficiency of your portfolio. Can you get rid of some of your active funds that trigger high income distributions and thus your tax burden year after year? Look for more passive strategies that may have similar market exposure and returns, but with much lower turnover and greater tax efficiency.
When rebalancing, you may want to move certain tax-inefficient assets, like REIT funds, into your IRA or 401(k) to minimize your tax burden.
Realize your portfolio is only part of the puzzle. Your portfolio isn’t the only important thing. Look at all the issues confronting you. Consider all tax, accounting, estate planning, insurance, business management, retirement and charitable-giving considerations.
Even if you are a do-it-yourselfer, consider hiring a fee-only financial adviser.
After all, you don't necessarily fix your own car or treat your own illness — you hire a mechanic or a doctor. Your financial well-being is just as important. In this fast-paced global economy and complex tax system, professional advice is almost always worth the cost.
Anthony D. Criscuolo, Certified Financial Planner (CFP), portfolio and client service manager with Palisades Hudson Financial Group’s Fort Lauderdale, Florida, office. Palisades Hudson is a fee-only financial planning firm and investment manager based Fort Lauderdale, Florida, with more than $1.3 billion under management. It offers financial planning, wealth management, and tax services. Its Entertainment and Sports Team serves entertainers and professional athletes. Branch offices are in Stamford, Connecticut; Atlanta, Georgia; Portland, Oregon; and Austin, Texas.
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