YOUR MONEY
Year-End
Investment Strategies
While 2008 is just around the corner you still have time to
look for tax-saving opportunities before year-end. Today,
let’s look at tax loss harvesting from the taxable portion
of your investment portfolio.
Have you analyzed your portfolio to get a view of your 2007
gains and losses? This is an important task that you should
pencil in on your annual financial to-do list every December.
If you have gains for the year in your investment portfolio,
you should seriously consider the tactic of “tax loss
harvesting.”
Tax loss harvesting is simply selling assets that have fallen
below their purchase price before year-end to offset your
annual capital gains, thereby reducing the amount of taxes
you will have to pay.
This investment strategy is often overlooked, but can prove
quite beneficial. In fact, a Fidelity Institute study found
that 67 percent of households do not take full advantage of
their unrealized losses. Of the 252,000 taxable accounts held
by the surveyed households, the Institute found that about
26 percent of them had sufficient losses to take full advantage
of the $3,000 maximum allowable deduction.
Wash Away Your Underperformance Blues
This year may look particularly inviting to take
advantage of losses in your taxable investment portfolio.
The stock market has given investors a bumpy ride in the second
half of this year. The subprime mortgage mess in the credit
markets is a key culprit causing the increased price volatility
in the stock and bond markets. The subprime situation has
cost some big banks and brokerage firms billions in losses
this year. As of this writing, the CEOs of two of the biggest
of these firms have lost their jobs; and these businesses
will likely be writing off quite a few billion in losses for
2007.
While a typical individual investor is unlikely to have a
high level of exposure in his portfolio to companies holding
billions in questionable subprime debt, his or her investment
portfolio is still likely impacted. Marketplace nervousness
about the credit markets crunch has dragged down the stock
prices of numerous companies, many of which have nothing to
do with making or holding subprime loans. You may be directly
holding many such stocks in your portfolio.
Can you turn this situation to your advantage? Yes. As most
CPAs know there is a rule called the “wash sale.”
This rule prohibits an investor from claiming a capital loss
for tax purposes if the investment in which the loss originated
is repurchased within 30 days.
If you now sell a position to create the tax loss, you are
precluded from buying it back for 31 days. As an unintended
result you may miss out on appreciation if part of the market
in which your portfolio was allocated happened to swing up
during that period.
There is a strategy to overcome this obstacle: Buy a stock
that is similar (just make sure it isn't too analogous per
IRS regulations). Say you sold your Merck stock at a loss.
If you wanted to maintain a pharmaceuticals allocation you
could buy Pfizer. Or, you could buy the Pharmaceutical HOLDR
(PPH), which is an exchange-traded fund that tracks the shares
of 21 of the world’s largest drugmakers. What would
work best for you? Your investment advisor can help by revisiting
your intended portfolio allocations and weightings, and evaluating
which substitute investment vehicle makes the most sense for
your portfolio goals.
One pitfall to look out for is in the area of mutual funds
when you are doing tax harvesting. Mutual funds frequently
make year-end capital gains distributions that can wreak havoc
on your strategy. For example, if you're planning to sell
a mutual fund with gains to use up some of your loss carryforwards,
do it before the fund makes it’s the year-end distributions
that are required by law. That lets you control your gains
and losses. While it may be too late for you to take advantage
of this tactic this year, make yourself a financial to-do
note for next October to reexamine your mutual fund holdings
in your taxable portfolio and look for this type of opportunity.
Think carefully before you purchase a mutual fund at this
time of year, too. Wait until after its year-end distribution.
Otherwise, you’ll get caught having to pay taxes on
gains that only the fund’s older shareholders realized.
Planning for a Healthy
Investment Year
Take some time before year-end to see if your portfolio
allocation is properly positioned or to rebalance it if
you have not done so within the last year.
Be smart and reduce your taxes—and at the same time
balance your portfolio. These issues are complex so please
find an excellent investment advisors and CPA to help guide
you through these strategies.
Guy McPhail, CPA, CFP®, is president of Zdenek
Financial Planning, LLC.
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