Portfolio Renovation for 2015
With just a few weeks left in the year, time is running out on year-end tax saving moves. While it can be difficult to focus on tax preparation during the hectic holiday season, the seven steps outlined below could pay dividendsA cash payment to investors who own stock in the company. in 2015 and beyond.
1. Consider Rebalancing
At the start of each year, the financial press and mutual fund providers will talk a lot about rebalancing—specifically, as something to include in your New Year’s resolutions. We have a different take, however.
First, a refresher: Rebalancing involves selling shares of those stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company., bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. or funds in your portfolio that have had gains and reinvesting the proceeds in assets that are currently underweighted in your portfolio. For example, consider a hypothetical portfolio comprised of three mutual funds a year ago, with one-third in a large-cap domestic fund, one-third in an international stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. fund and one-third in a U.S. Treasury bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. fund.
Due to variations in the performance of these funds over the past year, the investor’s asset allocation today would be noticeably different, as Treasury bonds have underperformed stocks, while U.S. stocks have outperformed international stocks. The conventional wisdom for this investor would be to rebalance back to the original asset allocation. For someone focused on a specific riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. profile or keeping a strict asset mix, rebalancing could be a valid practice.
At Adviser Investments, we contend that unless a portfolio has seriously diverged from the original allocation, rebalancing is often unnecessary or of little benefit. In looking at the effects of portfolio rebalancing at various regular intervals versus the effects of rarely or never doing so, we’ve found that there is little to no performance advantage to automatically resetting a portfolio’s allocation every year. Plus, those who regularly rebalance may be burdening themselves with taxes on gains and any fees generated by the necessary transactions.
2. Know Your Funds’ Distribution Dates to Avoid Taxable Income
We mentioned this in the November 21 issue of the Adviser Fund Update, which included distribution calendars for Fidelity and Vanguard (there’s an update to Vanguard’s calendar below), but a review of year-end investing wouldn’t be complete without it: If you are planning to make any additional purchases in 2014, it’s important to know when your funds will be making their December distributions.
Why? Taxes. If you buy shares of a fund prior to its “ex-dividend” date (the date on which the fund’s price is reduced by the amount of the dividendA cash payment to investors who own stock in the company. or capital gain), you will have to pay taxes on additional distributions on those shares, even though you didn’t own the shares when that income was “earned.” Buying shares just prior to the ex-dividend date is often referred to as “buying the distribution,” and it’s something we avoid whenever possible for our clients.
3. Should You Take a Loss?
If you have a loss in a fund you own in a taxable account, it may make sense to sell your shares to avoid a distribution, rather than have the distribution add to your tax bill. However, you’ll need to consider the size of the distribution, the size of your loss and any fees that may be incurred in the sale before doing so. If you own the fund in a tax-deferred account, distributions will not affect your taxes.
As you consider your tax-planning options, however, be aware of the “wash-sale” rule. This rule is designed to prevent investors from temporarily selling shares to gain a tax advantage and then repurchasing them a short time later.
Under the wash-sale rule, you lose the ability to claim a tax loss if you make a purchase of the same fund (or a substantially similar fund) 30 days prior to or 30 days after a sale. Therefore, if you sold 100 shares of XYZ fund Dec. 22 at a loss and bought the shares back Jan. 5, 2015, you could not claim a capital loss. The same rule would apply if you bought shares Nov. 14 and sold them on Dec. 12. These rules apply whether you made a direct purchase or reinvested a fund distribution.
Assuming you abide by the wash-sale rule, harvesting tax losses can be a cost-saving aspect of your investment strategy. You should also be careful not to sell shares of a fund you won’t be able to replace. For example, if a fund is closed to new investors and you sell all of your shares, you won’t be able to buy back in.
As always when it comes to tax planning, our best advice is to speak to a trusted tax professional to help you come up with a course of action that works best for you.
4. Think About Whether to Opt Out of Automatic Reinvestment
One strategy that we employ for a number of our clients is to have their income and capital gains distributions deposited into a money market fund, rather than automatically reinvesting the proceeds in the fund that generated them. This provides the flexibility of reinvesting in the fund at a later date or, as part of a rebalancing strategy, using the cash to add to other funds that may have underperformed recently.
5. Maximize Opportunities for Tax-Deferred Growth
It’s a well-known fact that 401(k)s, IRAs and other retirement accounts are a great way to keep assets growing tax-deferred. Therefore, consider contributing the maximum amounts allowable to each account every year. Depending on your employer’s plan, you may be able to defer up to $17,500 in earnings to a 401(k) or 403(b) plan in 2014 (the limit increases to $18,000 in 2015). If you will turn 50 before Dec. 31, 2014, and your plan allows it, you can contribute an additional $5,500 (and the same in 2015). For IRAs, the maximum contribution in 2014 and 2015 is $5,500, plus a $1,000 “catch-up contribution” for those who turn 50 before during either calendar year. You have until April 15, 2015, to make your 2014 contributions, but if you do it now, your money can enjoy the benefits of tax-deferral and compound interest sooner rather than later.
6. Don’t Forget Your Required Minimum Distributions (RMDs)
If you have tax-deferred accounts, you will be required to withdraw a minimum percentage each year after reaching a certain age. The RMDA required minimum distribution is the amount of money that must be withdrawn each year from tax-deferred retirement accounts once the beneficiary reaches retirement age (72, according to IRS rules). rule exists to make sure that savings in retirement accounts are actually used for retirement and not just passed on to heirs.
You generally have until April 1 of the year following the calendar year in which you turn 70½ to take your first RMD (in subsequent years, there is a December 31 deadline). These rules apply to any retirement account in which you contributed tax-deferred assets or had tax-deferred earnings, such as Traditional IRAs, RolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax. IRAs, SEP-IRAs, 401(k) and 403(b) plans. Note that Roth IRAs are not subject to RMD rules.
The RMD is calculated (in most cases) by dividing the adjusted market value of your tax-deferred retirement account as of December 31 of the prior year by an applicable factor taken from the IRS life expectancy tables. If you fail to take your RMD from your retirement account, you will be assessed a penalty equal to 50% of the amount you should have withdrawn, in addition to normal income taxes. These are heavy penalties, so clearly it’s in your best interests to take these RMDs, something we help our clients with each year.
7. Focus and Finish
While taxes are one of the last things you may want to think about during the holiday season, taking the time to fine tune your portfolio now may help prevent bigger headaches and tax bills come April. That said, restructuring a portfolio and moving assets in an attempt to avoid distributions can be tricky, which is why we recommend you consult with a professional tax adviser before doing so.
Updated Vanguard Distribution Dates
As mentioned above, we reported on distribution dates for Fidelity and Vanguard funds in our November 21 issue. Vanguard released its full distribution calendar December 9, an updated list is below. Note that there were some funds that went ex-dividend on December 17, prior to publication.
Record Date: 12/16 Ex-Dividend Date: 12/17
500 Index, Capital Value, Consumer Discretionary Index, Consumer Staples Index, DividendA cash payment to investors who own stock in the company. Appreciation Index, Energy Index, EquityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. Income, Explorer, Explorer Value, FTSE Social Index, Growth and Income, Health Care Index, High Dividend YieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. Index, Industrials Index, Information Technology Index, Materials Index, Morgan Growth, Selected Value, Short-Term Inflation-Protected Securities Index, Strategic Equity, Strategic Small-Cap Equity, Telecommunication Services Index, U.S. Growth, U.S. Value, Utilities Index, Wellesley Income, Windsor, Windsor II.
Record Date: 12/22 Ex-Dividend Date: 12/18
500 Index ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., Consumer Discretionary ETF, Consumer Staples ETF, Dividend Appreciation ETF, Energy ETF, Extended Duration Treasury ETF, Health Care ETF, High Dividend Yield ETF, Industrials ETF, Information Technology ETF, Materials ETF, MegaCap Growth ETF, MegaCap ETF, MegaCap Value ETF, Russell 1000 Growth ETF, Russell 1000 ETF, Russell 1000 Value ETF, Russell 3000 ETF, S&P 500 Growth ETF, S&P 500 Value ETF, Short-Term Inflation-Protected Securities ETF, Telecommunication Services ETF, Utilities ETF.
Record Date: 12/18 Ex-Dividend Date: 12/19
Developed Markets StockA financial instrument giving the holder a proportion of the ownership and earnings of a company., Emerging Markets Stock, European Index, Extended Market Index, Financials Index, World ex-U.S. Index, World ex-U.S. SmallCap Index, Global ex-U.S. Real Estate Index, Global Minimum VolatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in., Growth Index, LargeCap Index, MidCap Growth Index, MidCap Index, MidCap Value Index, Pacific Stock Index, REIT Index, SmallCap Growth Index, SmallCap Index, SmallCap Value Index, Tax-Managed Capital Appreciation, Tax- Managed SmallCap, Total International Stock, Total Stock Market, Total World Stock, Value Index.
Record Date: 12/19 Ex-Dividend Date: 12/22
Capital Opportunity, Dividend Growth, Emerging Markets Select Stock, Energy, Health Care, International Explorer, International Growth, MidCap Growth, Precious Metals & Mining, PRIMECAP, PRIMECAP Core.
Record Date: 12/24 Ex-Dividend Date: 12/22
Emerging Markets Stock ETF, European ETF, Extended Market ETF, Financials ETF, World ex-U.S. ETF, World ex-U.S. SmallCap ETF, Developed Markets ETF, Global ex-U.S. Real Estate ETF, Growth ETF, LargeCap ETF, MidCap Growth ETF, MidCap ETF, MidCap Value ETF, Pacific ETF, REIT ETF, Russell 2000 Growth ETF, Russell 2000 ETF, Russell 2000 Value ETF, S&P MidCap 400 Growth ETF, S&P MidCap 400 ETF, S&P MidCap 400 Value ETF, S&P SmallCap 600 Growth ETF, S&P SmallCap 600 ETF, S&P SmallCap 600 Value ETF, SmallCap Growth ETF, SmallCap ETF, SmallCap Value ETF, Total International Stock ETF, Total Stock Market ETF, Total World Stock ETF, Value ETF.
Record Date: 12/24 Ex-Dividend Date: 12/26
Balanced Index, Convertible Securities, Global Equity, Inflation-Protected Securities, International Value, Tax- Managed Balanced, Wellington.
Record Date: 12/26 Ex-Dividend Date: 12/29
Diversified Equity, Market Neutral, STAR, STAR LifeStrategy funds, Target Retirement funds.
About Adviser Investments
Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the fifth consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2017. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015 and 2016.
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Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
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Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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