While it may feel like 2015 just arrived, that New Year’s baby is fast becoming a senior citizen. For investors, that means some year-end tasks remain on the to-do list.
But that doesn’t necessarily mean placing your bets about which stocks or sectors you believe will do well — or poorly — in 2016. Instead, investment professionals say, year-end financial tasks often pertain to taxes or general planning matters.
Here are some tasks investors should handle before the year ends:
Tax-loss harvesting. Tim McGrath, managing partner at Riverpoint Wealth Management in Chicago, says tax-related questions make up the bulk of client discussions in the fourth quarter, including a look at capital gains.
Short-term capital gains are the net gains from the sale of shares owned for one year or less. In a nonqualified account, taxation of these gains can put a dent in returns. To offset those effects, McGrath uses tax-loss harvesting, the process of selling a security that shows a loss. In some cases, investors or advisors can replace the sold security with something similar. That maintains the desired asset allocation mix while avoiding a potential tax hit.
“Tax-loss harvesting is obviously a big thing at the end of the year,” McGrath says. “We already did some of that when the market dropped, just in case it bounced back. But we’ll look at it again,” he says.
Bob Andres, founder and chief investment officer of Andres Capital Management in Berwyn, Pennsylvania, says the fourth quarter is typically when investors review their holdings and plan to sell securities that no longer meet their portfolio’s objectives.
He cites the example of municipal bonds. “The outperformance of municipal securities over the last two years may provide profit-taking opportunities to offset losses in other asset classes,” he says. “Gains in one asset class may be used to offset losses in another, dollar for dollar. Tax swapping is the simple act of selling a holding and replacing it with one of similar but measurably different characteristics, such as longer maturity or different coupon or rating.”
Take your distributions. Eric Kies, chief compliance officer at The Planning Center in Moline, Illinois, also emphasizes the need to take required minimum distributions from individual retirement accounts. Investors who own traditional IRA accounts must begin taking their distributions no later than April 1 following the year in which they turn 70 1/2, and by Dec. 31 every year after that. Investors who fail to make the withdrawals face penalties.
“Depending upon the client’s situation, there may be opportunities to convert traditional IRA assets to a Roth IRA by year end,” Kies says. Often, retirees find that the Roth conversion makes sense. Investors may contribute to a Roth at any age, and they are not required to take the yearly minimum distributions. In addition, withdrawals from Roth IRAs are not taxable until six months after the account holder turns 59, and as long as he has held the funds for at least five years.
Each investor’s situation is different, which is why the fourth quarter is a good time to evaluate your overall financial position.
“We look at clients on an individual basis. Some might be in a higher tax bracket in 2016 than they are in 2015, or just the opposite. For some clients, we might hold off on making changes just because we know it’s a big year. They’re retiring or they have a big distribution, so the last thing we want to do is to add anything to enhance that this year,” McGrath says.
In those situations, it might benefit the investor to wait until 2016 to make any significant portfolio shifts.
“Towards the end of the year is the time that we reassess all investments that we’re in for clients, to see if there are any strategies that we’re going to change. We’ll be doing tactical plays throughout the year, but just a complete overview on every individual security, typically we do it in fourth quarter or the first quarter. That’s when we implement a lot of things,” McGrath says.
Plan. Andres also takes a tactical approach, looking ahead at what he expects from markets and economies in the new year. This year, he believes investors should be aware of effects from Federal Reserve interest-rate tightening.
“A Fed tightening will put pressure on interest rate-sensitive securities, such as real estate investment trusts and utilities. A tightening will also put additional pressure on corporate high-yield products. I would recommend investors allocate money to Japan, and dependent on their investment time horizon, some funds to emerging markets,” he says.
Emerging-market stocks have been poor performers recently, but over time, they can outpace developed-market stocks, although they are typically more volatile. For investors who have several years before they need to draw from their accounts, taking on the additional risk may prove worthwhile.
Andres also suggests investors look toward global equities, including European stocks, to offset potential effects of Fed rate increases. In addition, he says, “I would look at the energy sector but focus my attention to oil and gas pipeline structures, as they are much less volatile and thus more defensive. I would also make a small commitment to a basket of commodities.”
Of course, advisors adhere to different investment philosophies and guide their clients accordingly.
Kies uses a strategic, rather than tactical, approach to investing. He avoids making predictions and prefers to keep clients invested in a portfolio designed to match their risk tolerance and objectives. Within a broadly diversified portfolio, investors have exposure to various regions, sectors, asset classes and market capitalizations at all times.
Investors using that approach generally make no portfolio changes because of what the calendar says. Tax-related actions, such as making sure contributions or withdrawals are completed by year’s end, are separate planning concerns, unrelated to the investment philosophy.
“If the initial planning and modeling are done well upfront, there is very little from a strategic perspective that needs to be done, such as trying to predict what the market will do in 2016 or reacting because an asset class had a bad year. However, there are shorter-term aspects, such as volatility-based rebalancing, that is much more based on current market movements,” Kies says.
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