Start off 2016 right: 8 year-end investing dos and don'ts
December is typically a low-key month in the stock market, which makes it the ideal time to do some portfolio housecleaning. While some tasks can wait until after the New Year鈥檚 Eve party, other chores (like topping off your workplace retirement contributions for 2015 and completing tax-slashing portfolio maneuvers) have a hard Dec. 31 deadline.
Mistakes can happen when investors face聽a time crunch, so we鈥檝e composed this list to help you make the right year-end investing moves.
1. Avoid聽buying a mutual fund in December
Many actively managed mutual funds make their annual distribution of gains to shareholders 鈥� all shareholders 鈥� at the end of the year.
It doesn鈥檛 matter if an investor has owned the fund for 15 years or bought it 15 minutes before the distribution: If you own the fund in a聽taxable聽account those gains will be reported to the IRS and you鈥檒l be responsible for covering the entire tax tab. (Note: Taxes on distributions don鈥檛 apply if you hold the fund in a tax-deferred account, such as a traditional IRA, or a tax-exempt one, such as聽a Roth IRA.)
To avoid paying taxes on gains that you didn鈥檛 have time聽to enjoy, wait until after distributions are made to invest in a mutual fund.
2. Hold off on cashing in your winners
聽reward (or, rather, penalize less harshly) those who hold onto their investments for more than one year. Investments in taxable accounts that are sold before the one-year anniversary are subject to a higher tax rate on gains than ones that have been allowed to simmer awhile.
Here鈥檚 how the聽聽are applied:
- Gains on investments that you鈥檝e held for one year or longer are considered聽long-term capital gains聽and are taxed at聽15% for most people. (If you鈥檙e in a lower tax bracket you might not owe any taxes at all on your long-term gains. Those in the higher brackets may pay up to 20%.)
- Gains on investments sold less than a聽year after purchase are subject to聽short-term capital gains聽tax rates and in most cases will be taxed at the higher ordinary income tax rate. If you are single and make between $37,451 and $90,750, you鈥檙e looking at a 25% or higher tax hit.
For those reasons, you want to be strategic about聽when聽you sell. But just as important is identifying the聽what听补苍诲听why聽behind your sales, which brings us to our next important 鈥渢o do鈥� before the calendar turns to 2016.
3. Check your portfolio balance
Reducing your portfolio鈥檚 volatility requires maintaining the right mix of assets 鈥斅爏tocks, funds, ETFs or other investments 鈥斅爐hat don鈥檛 all react the same way to market events. That way when one type of investment hits a rough patch, you take less of a hit because the others balance out your returns.
Over time that balance can get thrown out of whack, which is why it鈥檚 important to review your allocation of assets at regular intervals. The聽聽that investors check their asset allocation every six to 12 months. But聽buying and selling can generate fees and trigger taxable events, and the SEC聽advises looking for ways to minimize those expenses wherever possible.
Some investment products and services automatically re-allocate holdings to maintain the proper balance for investors. Target-date or 鈥渓ife-cycle鈥� mutual funds base the mix of assets on the amount of time investors have until they need the money in retirement. Holdings are adjusted to include more conservative investments as the retirement date draws near.
Many robo-advisors do the same thing with built-in rebalancing features that scour client portfolios 鈥� sometimes daily 鈥� to identify overweighted or underweighted holdings and take into account the tax consequences of each adjustment.聽,听,听补苍诲听聽are among the robo-advisors offering automatic rebalancing.
4. Sell stinkers听补苍诲听use losses to offset gains
Restoring balance to your portfolio may require some selling and buying. If the investments are held in a taxable account, now鈥檚 the time聽to examine your holdings for tax-saving opportunities through a strategy called聽.
Tax-loss harvesting is a way for investors to offset 鈥� or cancel out 鈥� any capital gains or income taxes they owe by applying capital losses against the amount. The IRS allows unmarried taxpayers and those who are married and filing jointly to offset as much as $3,000 a year in gains ($1,500 a year if you鈥檙e married and filing separately). Amounts over the limit can be carried forward into future tax years.
5. But avoid selling聽solely for the tax break
As nice as it is to put investment losses to good use, don鈥檛 let a short-term tax strategy usurp your long-term investing strategy. Selling a stock that shows promise just because it is has experienced a near-term loss robs you of future gains. (And if you鈥檙e thinking about turning around and buying it right back again, don鈥檛:聽聽will come back and ruin your New Year鈥檚 celebration.)
Before you sell an underperforming stock, identify whether it lost value due to a fundamental change in the underlying business. If not, then in most cases you鈥檙e better off letting the healing power of time and the magic of compound interest carry you back into the black.
6. Catch up on contributions to your workplace retirement account
You鈥檝e only got until Dec. 31 to fully fund your workplace retirement plan 鈥斅�401(k), 403(b), 457 or TSP. The contribution limit for 2015 is聽$18,000, or $24,000 if you鈥檙e 50 or older.
Those who haven鈥檛 fully funded the account throughout the year might have to devote the majority of those final 2015 paychecks to the cause. Talk to your payroll department about your options. If there鈥檚 not enough time for them to do the paperwork, see if you can send a check directly to the plan administrator so they can complete the contribution by the deadline. Also check to see if the company match (if you have one) applies to last-minute聽lump-sum contributions.
Scrambling and scraping up money may be聽a hassle, but it鈥檚 worth it 鈥� and not just to get your investment dollars in play. Remember, every dollar you contribute lowers your taxable income for the year. So this is a great year-end two-fer.
7. Do a Roth conversion, especially if you鈥檙e in a lower tax bracket in 2015
Spreading your investments across accounts with different tax treatments will give you flexibility when you start using that money to pay for expenses when you retire. For example, in flush years when you鈥檙e in a higher tax bracket it makes sense to take tax-free withdrawals from your Roth IRA. In years where you鈥檙e in a lower bracket, tapping your traditional IRA is smart because withdrawals are taxed at your ordinary income tax rate.
Now鈥檚 the perfect time to review whether it makes sense to convert all or even just part of your traditional IRA (or SEP or SIMPLE IRA) into a Roth. Because the conversion produces a tax bill (the money you roll over into a Roth counts as 鈥渆arned income鈥� for the year), ask yourself: Do I expect to be in a higher tax bracket next year? If so, it makes sense to pay the piper (less) now and do the conversion. See our roundup of the聽.
If you expect to have less in earned income next year, you could wait to do the conversion. However, keep in mind that as earnings in the traditional IRA continue to grow, it will add to your income tax bill when you eventually do convert. And, lastly, if you鈥檙e a high income earner and don鈥檛 qualify for the Roth,听.鈥�
8. Make your 2015 IRA contribution sooner rather than later
Even though the deadline for 2015 contributions聽to an IRA is Monday, April 18, 2016, it behooves investors to get ahead of the game and put those investing dollars to work ASAP. Every month you delay investing is another month of compounding growth lost.
Even if you don鈥檛 have $5,500 available to fully fund your IRA right now, sock away whatever you can (or聽聽if you don鈥檛 have one already) in anticipation of the stock market waking up in January. It鈥檒l be the best year-end gift you can give yourself for years to come.
Dayana Yochim is a staff writer at NerdWallet, a personal finance website. Email:dyochim@nerdwallet.com. Twitter:聽.
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