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Coming into this year, true bulls were few and far between. The European
debt crisis was in full swing, the U.S. economy was no great shakes itself,
and emerging markets--long considered the engines that would propel global
growth in the future--appeared to be slowing down. After the market posted
meager gains in 2011, many Wall Street analysts were predicting more of the
same in 2012; 16 analysts surveyed at the start of this year predicted
average gains of 8% for the S&P 500 in 2012.
About the Author
Christine Benz is Morningstar's director of personal finance and author of
30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances
and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success.
Follow Christine on Twitter: @christine_benz and on Facebook.
Contact Author | Meet other investing specialists
Notwithstanding a recent hiccup, stocks have surprised on the upside:
Through late September, the S&P has doubled those analysts' predictions, and
bonds and foreign stocks have been decent, too. Given that runup, it's a
decent time to take stock of where your portfolio is today. And this year,
it's particularly important to conduct your year-end checkup before the year
is actually over. That's because a host of tax changes are set to go into
effect next year that might have an impact on your investment portfolio, and
acting preemptively could save you some money.
Here are four key tactics to consider between now and year-end.
1) See if Rebalancing Is in Order
After a year like 2011, when stocks posted meager gains and bonds were solid
but not explosive, it wasn't a huge deal if investors let rebalancing go by
the wayside. The market moves were simply not large enough to make a huge
difference. Fast-forward a year, however, and rebalancing starts to look
more important, especially for investors who haven't made any changes since
the start of the current market rally. A portfolio split 50/50 between
stocks and bonds in early 2009, at the tail end of the bear market, would
now be 63% equity and 37% bond.
Of course, moving a bunch of money into low-yielding bonds isn't an
appealing prospect, but if you've checked your target asset allocation and
you're woefully light on bonds and/or cash, derisking immediately is the
name of the game. This article discusses how you can gradually enlarge your
bond stake to avoid getting burned.
In addition to reviewing your exposure to the major asset classes, also
check up on your intra-asset-class exposures using Morningstar.com's X-Ray
function. Growth stocks have been on a tear recently and in aggregate look
fairly to richly valued based on Morningstar analysts' price/fair value
estimates. For benchmarking purposes, each of the large-cap squares of the
Morningstar Style Box accounts for about one fourth of the U.S. market's
value; stocks in the mid-cap row account for roughly 6% apiece; and each of
the small-cap squares contributes 3% of the market's value. For some context
, when setting your developed/developing markets split, the FTSE All-World
ex-U.S. index currently features 25% in emerging markets and the rest in
securities from developed markets.
2) Consider Tax-Gain Harvesting
In a normal year, I would say there's no reason to hustle to rebalance your
portfolio before year-end. But this year is different because a host of Bush
-era tax rates that were favorable to investors are set to expire at the end
of December, barring Congressional action. Top of mind for rebalancers?
Long-term capital gains taxes, which are set to rise from 15% currently to
20% for those in the highest tax brackets, and to 10% from 0% for those in
the 15% tax bracket or below. (This article summarizes some of the key
investment-related tax changes that will kick in next year.)
If your portfolio review indicates that it makes sense to lighten up on a
winning position that you've held for more than a year--either because its
valuation seems high or because it's too large a piece of your portfolio--it
's a layup to do so this year, at today's low capital gains rates. After all
, tax rates may stay the same, but no one's talking seriously about them
going any lower than they are right now. On the other hand, there are risks
in going overboard in an effort to lock in low long-term capital gains rates
. If you don't have a convincing fundamental impetus for selling a security
and tax rates stay the same, unloading it now will trigger a gain that you
might have otherwise deferred. This article provides an overview of key tips
and traps to bear in mind if you're considering selling something
preemptively.
3) Check Your Asset Location
Also on the tax horizon? A hike in the tax rate on qualified dividends,
which will move from 15% for those in the 25% tax bracket and above to
investors' ordinary income tax rates. Investors in the 10% and 15% tax
brackets, who currently pay no taxes on qualified dividends, will also see
their dividend payouts dunned at their ordinary income tax rates. That
harsher tax treatment suggests that dividend payers, such as investments
that kick off a lot of ordinary income (bonds) and short-term capital gains
(fast-trading stock funds), clearly belong under the heading of "hold in tax
-sheltered accounts."
True, relocating dividend payers to a tax-sheltered account could carry a
tax hit of its own: If a dividend-paying security has appreciated since you
purchased it, moving it out of your taxable account and into a tax-sheltered
wrapper could trigger a capital gains tax bill. (See above.) Nonetheless,
relocating dividend payers to your IRA or 401(k) in 2012 makes sense on a
few levels. First, any capital gains taxes resulting from the trade might
well be lower in 2012 than in the future. And second, even without higher
tax rates, dividend payers always made more sense in tax-sheltered accounts
than they did in taxable ones, as I argued in this article.
4) Investigate Roth Conversions
Yet another maneuver that's worth putting on your radar between now and the
end of 2012 is converting traditional IRA assets to Roth, a tack that would
have multiple benefits in a higher-tax climate. First, the taxes due upon
conversion would be based on 2012's relatively low income tax rates. Second,
Roth assets will be even more valuable if income tax rates rise in the
future because Roth withdrawals are tax-free. Finally, Roth assets aren't
subject to the new Medicare surtax going into effect in 2013, which I
discussed in this article.
Yet as attractive as it might seem to move assets over into the Roth column,
this strategy won't be for everyone. Whether your long-term tax savings
will offset the taxes you'll incur to do the conversion is a key swing
factor, as is the potential for conversion-related income to push you into a
higher tax bracket. This article tackles some of the key questions related
to Roth conversions, but the wisdom of converting is highly individualized.
For that reason, it's best to check with a qualified tax advisor before
moving forward. |
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