Posted Sunday, October 29, 2006
Investors are often encouraged to put their portfolios on autopilot. But every now and then, it's important to check to see if your investment accounts are still on the right course-and to make necessary adjustments. The end of the year is a perfect time to do just that.
With two months left before 2007, here are some steps to consider:
Harvest your tax losses. In other words, sell some of your poor-performing stocks in order to lock in those losses. "In addition to stemming the bleeding from those losses, you can take advantage of the tax benefit," says Donna LeValley, contributing editor of J. K. Lasser's Your Income Tax 2007.
You can use those capital losses to offset capital gains elsewhere in your portfolio, thereby reducing your 2006 tax bill. If you don't have any gains to speak of, you can use those losses to deduct as much as $3,000 from your ordinary income. And any losses above that amount can be carried forward to future tax years.
But remember: To take advantage of the tax loss, you cannot step back into the exact same investment within 30 days of the sale. This is known as the "wash sales" rule.
This doesn't prevent you, though, from immediately replacing your investment with a similar security-selling Ford at a loss, for example, and buying GM.
Wait until next year to buy mutual fund shares. By law, funds must pass along to their shareholders all the capital gains they've realized throughout the year by buying and selling stocks. Typically, funds distribute these gains-and the corresponding tax bills-in late November or December. This means that if you buy into a new fund now, you could be presented with an immediate tax bill for gains that you never even enjoyed.
Tom Roseen, senior research analyst for Lipper, says that fund investors should brace themselves for even bigger tax bills this year than in 2005 because of larger gains. Fund investors should be most worried about stepping into tax bills in real-estate funds, precious metals funds, and emerging markets stock portfolios, according to the fund tracker Morningstar.
Charitable giving. If you're in a giving mood, the end of the year is a great time to consider donating appreciated stock to a qualified charity. By doing so, you avoid having to pay capital gains on the investment. And since the charity won't have to pay taxes when it sells the security, it will enjoy the full value of the stock sale. Meanwhile, you're allowed to deduct the value of the appreciated stock up to 30 percent of your adjusted gross income.
Rebalance. The end of the year is also a perfect opportunity to reset your portfolio back to your desired mix of stocks and bonds. That's because over time, your allocations to each asset category will change based on the relative performance of the equity and fixed-income markets.
Say you want to invest 50 percent of your money in equities and the other 50 percent in bonds. And let's say you haven't rebalanced over the past three years. In that time, the S&P 500 has gained 12.3 percent a year while the Lehman Brothers Aggregate bond index has risen only 3.4 percent annually. This means that your original 50 percent stock/50 percent bond portfolio is now 56 percent equities and only 44 percent fixed income.