It’s easy this time of year to get so wrapped up in holiday shopping and family gatherings that you can forget about the financial housekeeping that’s crucial before the end of the year. Properly setting up your portfolio now for 2014 can help you brace for volatility in the markets, and could lower your tax liability in 2013.
Even if you have paid attention to your portfolio this year, the onset of Fed tapering is a reminder that things have been moving quickly in this market. The market reacted strongly to the news Wednesday, with the Dow and S&P 500 hitting new record closes. Stocks have had their best year since 1997.
"We've had a nice run-up" in stocks, says Bob Jones, CEO of Central Trust and Investment Company of Jefferson City, Miss. "Don't be afraid to take some money off the table [by selling to realize profits]. The stock market probably has more danger on the downside than opportunity on the upside."
It's also a time to see if your current portfolio still adheres to your long-term allocation strategy. Stocks have increased about 150 percent since 2009, while bonds yields have been lower. "A conservative investor who had an appropriate 50-50 split between equities and fixed income then, without any rebalancing in the interim, might have a 75-25 split now," says Paul Jacobs, chief investment officer of Palisades Hudson Financial Group, calling "inevitable" a future downturn that would eat into portfolio profits.
Look at stocks that have seen the biggest gains and whose valuation may be out of whack, or that are in industries — like telecommunications and utilities — that could fall if interest rates were to rise. This strategy is particularly important for high-earners this year. Those in the highest tax bracket will face long-term capital gains taxes of 23.8 percent and short-term gains taxes of 43.4 percent (including a 3.8 percent surtax imposed under Obamacare).
When taking profits, try to keep trades to IRAs and 401(k)s, which are tax-deferred accounts. If that isn't possible, you'll need a strategy to avoid taxes. Selling enough big winners in taxable accounts could put you into another tax bracket or even potentially invoke the alternative minimum tax. Jacobs suggests selling some stocks now and some in January to split the impact between two years.
Sell the losers
Now’s not only a good time to take profits, but it’s also prudent to rid yourself of investment dogs for losses that will offset some of your gains. Certainly laggards in domestic stocks are fair game, but there are other potential candidates, too, such as international equities and fixed-income investments, as well.
The commencement of the long-awaited taper increases chances that interest rates will climb, which could have a painful effect on existing bond holdings, particularly those with low rates and short terms. “If they have a coupon of 4 percent but the prevailing interest rate is 5 percent, the open market will say the bond is worth less," said Chris Hobart, CEO and Founder of Charlotte, NC-based Hobart Financial Group. Selling low-yield bonds now could prevent you from having to sell at a discount later.
Still, it’s worth noting that even if interest rates go up, it will be likely be a slow climb, rather than a dramatic spike.
Give and spend wisely
Donating stocks with big gains to charities can benefit both you and the cause you want to support. Making a stock gift, rather than a cash gift, allows you to recognize the full value of the gains as a tax deduction. Any charitable donation, whether cash or another asset, can also be done through a donor-advised fund, in which you put money into the fund and take the tax credit this year but can distribute it in the future.
This is also a great time to make gifts to children or grandchildren. A 529 education plan is a great tool in many states. This year, you can give $14,000 in cash and assets to another person without owing taxes. Putting the money directly into a 529 education plan could have additional benefits, if your state is among the 34 that offer a full or partial deduction on your taxes for such contributions. Check out your state’s 529 tax benefits here. (The federal government does not offer a deduction for 529 contributions.)
One place to be careful placing your money at this time of year is mutual fund shares in a taxable account. Mutual funds may have to distribute some of their capital gains shares to owners, meaning that buying just before that happens could leave you with a full year’s tax bill without the underlying gains, says John Scherer of Middleton, Wisc.-based Trinity Financial Planning There is usually a fixed date on which the distribution happens. If you invest after the date, you're fine until next year.
You can also improve your financial position through spending. Check any type of flexible spending account for money that might vanish if not used by the end of the year. "Get a new pair of glasses, get next year's contacts, go to the dentist," said Scherer. Although technically such moves don’t involve your portfolio, by doling out expenses you would have needed to cover anyway, you potentially free up additional investment money for next year.
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