Taking stock of your investments and their tax ramifications isn’t just a year-end activity but something most advisors recommend investors and small business owners do more often.
“Markets can shift, sectors or styles can outperform or underperform, and this can lead to portfolios being out of balance,” says Zach Stuppy president of Brave Boat Capital Advisors in Boston.
That’s why, he says, people should review their investment planning strategy throughout the year and fine-tune it as needed if the markets pull back or accelerate forward.
[See: 10 Long-Term Investing Strategies That Work.]
Instead, some investors and businesses make the mistake of only reviewing their investment plan at the end of the year, which doesn’t leave much time to balance investing gains with losses to minimize their tax bill.
“Harvesting losses throughout the year allows you to not be forced to sell something in December or get to December with no losses to harvest,” Stuppy says.
Evolving timespans. All investment strategies start with a financial goal’s time frame.
Let’s say you have a short-term savings goal related to a specific event, says Terry Deever, president of Terry Deever CPA in Camarillo, California.
You can’t apply a long-term investment plan to a short-term goal because that usually involves trying to time the markets — the opposite of what investors should do. Instead, you may need several investing strategies, each one crafted for a specific objective, Deever says.
That strategy should consider taxes, although no investment plan should be based solely on tax ramifications, Deever says.
For example, if you plan to liquidate some of your savings to pay for an upcoming wedding, first look for investments with unrealized gains. Because you’ll owe taxes on those gains after selling the shares, find a money-losing investment in your portfolio that can be sold to offset your tax liability from the profitable shares. This practice is called harvesting losses.
“Taking the two together would mean minimal tax impact but still give you the proceeds you need,” he says.
Taxes aren’t the only reason to reshape an investment strategy. Investors also should rethink risk as a long-term financial goal approaches and requires shifting to a short-term investing strategy. Money invested through a college fund that will be needed for tuition in the next year or two should be allocated differently from the aggressive investments initially used to build those savings. Instead, investors should switch into safer holdings, such as a bond or bond fund, where the money will be protected better from market fluctuations, Deever says.
Even an emergency fund, which should be enough to cover three to six months’ worth of living expenses in the form of liquid assets, will need to be reviewed several times a year for those savings to earn as much as possible. You may want some emergency savings in certificates of deposit or a bond fund with a very short duration so that you are not locked in if interest rates rise but still earning more than what a savings account would pay, Deever says.
The shorter the investment’s duration, “the less it’s going to be affected by interest rate changes,” he says.
Business goals. Similarly, businesses that need to reinvest in equipment should plan ahead, factoring both risk and taxes into their decision.
For example, when one of Deever’s clients, a plastics company, needed to purchase a nearly half-million-dollar machine, he began shifting investments into safer assets months before the November purchase to ensure that the cash would be available.
They needed to reallocate some investments into safer holdings that could be liquidated easily, Deever says. Otherwise, there’s a potential risk the market will be down when you are ready to make the purchase.
Besides bonds, business owners can also move assets from a riskier mid-cap stock into a safer, large-cap dividend-paying stock or even invest in a short-term CD that won’t lose its value, he says.
[See: 20 Awesome Dividend Stocks for Guaranteed Income.]
To minimize taxes, business have a number of options. Generally, Deever says, business owners can deduct the entire cost of a fixed asset in the year they make the purchase.
Plus, any prior-year capital losses from the business’s Schedule D itemization can be carried forward, Deever says. For example, if an asset is sold at a $10,000 loss, and there are no other capital gains, the IRS allows businesses to deduct up to $3,000 a year, leaving $7,000 that can be applied in future years, he says.
In-depth planning. For many CPAs, January through May is a tough time to do big-picture planning because all they want to do is “number crunch” until the federal tax deadline in April, and then they take time off in May, says Brett Anderson, president of St. Croix Advisors in Hudson, Wisconsin.
Although you should be tweaking your tax planning throughout the year, the deeper-dive conversations should happen in the off-season with your CPAs, Anderson says.
The timing of those discussions depends on when your fiscal year ends, especially if it’s June 30, he says. Anderson recommends having several meetings to plan throughout the year, and then make year-end projections approximately 90 days before the fiscal year ends. For businesses with fiscal years that end on Dec. 31, Anderson recommends having those conversations no later than September or early October.
Byron Ellis, managing director at United Capital in Woodlands, Texas, believes businesses should start even earlier by auditing their current financial status during the summer, which is often a slow time.
Review cash flow, year-to-date profits and cash reserves, he says. “The summer is a good time to plan for capital expenditures that may lead to a tax deduction,” Ellis says.
Individual investors, Anderson says, have a little more latitude, but they still should begin planning in the third or early fourth quarter because “a meaningful conversation during tax season is the wrong time.”
Many financial experts also recommend creating a to-do list for pending financial and investments tasks, such as updating or creating a will.
[See: 8 Things Not to Hide From Your Investment Professional.]
“Planning is not just a one-time thing,” Ellis says. “Life is constantly changing, and you need to be able to adjust and modify your financial plan.”
More from U.S. News
11 Great Investing Tips for Women
9 Investing Myths That People Still Believe
10 Skills the Best Investors Have
Investment Planning Is a Year-Round Job originally appeared on usnews.com
