The end of the year is a special time for investors. It is a great time to review your investments and make any necessary updates to your investment portfolio. It is a unique time, which provides some opportunities for investors but also a couple things they need to be cautious of.
Below are six tips for investors who want to set themselves up for success as one year ends and another begins:
1. Take an Inventory of Investments
The end of the year can be a great time to take an inventory of all the different investments you own and see if there are any opportunities to make changes to improve your portfolio moving forward. Do you have an opportunity to lower costs or be more diversified by switching to different mutual funds or exchange-traded funds within the same asset class? Does it make sense to consolidate a few funds covering the same asset class into one fund to simplify?
Though the end of the year can be a great time to make some needed updates to a portfolio, I would caution against anyone making changes based on recent performance or a prediction of future performance.
2. Review Asset Allocation and Rebalance If Necessary
It is important to review your asset allocation at the end of the year. As different investments in your portfolio experience different returns over time, your asset allocation drifts from its original target. If you find this is the case at the end of a year, you may want to rebalance your portfolio back to its target allocation.
Make sure this process is done with discipline, as directed by either a financial plan or investment policy statement. Do not use rebalancing as a way to make arbitrary changes to your asset allocation or a market timing call.
3. Sell at a Loss to Offset Gains
If you sold investments this year for a gain and will have a tax liability because of it, you may want to sell investments that have experienced losses in order to offset those gains for tax purposes. In addition to offsetting your gains, any losses over the amount of your gains can offset up to $3,000 of ordinary income to lower your taxes now, or be carried forward to reduce your taxes in the future.
If you plan to do this, make sure to sell those investments in time for the trades to settle before the end of the year.
4. Take Advantage of Low Tax Rates by Selling Appreciated Assets
If you are temporarily in a low tax bracket and eligible for the 0% or 5% tax rate on capital gains, you may want to sell appreciated assets to take advantage of the lower capital gains rates. This is important for people in the early stages of their careers or retirement who will see their incomes and (and tax rates) rise over time.
5. Watch Out for Capital Gains Distributions
Mutual funds typically pay out capital gains in the month of December, so investors need to be careful they are not buying into a tax liability when purchasing mutual fund shares this month.
If you buy shares of a mutual fund on or before what’s known as the ex-dividend date, you are entitled to your share of the capital gains distributions that are paid out and will have to pay taxes on them. If you plan to buy shares of mutual funds in December, you may want to make sure it is on the ex-dividend date or later.
6. Review Investment Account Beneficiaries
Many investment accounts require you to select beneficiaries who the assets in the account will pass to upon the death of the account holder, and these can be very important as they can supersede instructions in your will. The end of the year can be a great time to review the beneficiaries listed on your investment accounts and make updates if necessary.
Don’t Make Changes You Don’t Understand
Though the six tips above are helpful to keep in mind as we approach the end of the year, it is important people do not make any changes to their portfolio unless they fully understand what they are doing.
Decisions like which investments to hold and how to divide your portfolio among the various asset classes are complicated and should be made deliberately, whether as part of a financial plan or at least an investment policy statement. Most people do not have the expertise to implement these strategies themselves and should consult a financial professional for help.
Recent articles by Paul R. Ruedi: 6 Steps to Build a Diversified Portfolio