Year end portfolio management tips
As we near the conclusion of another prosperous year in the equity markets, it’s important to take some time to tend to your investment portfolios. A few simple activities can optimize the after-tax return of your portfolio and set you up for success in the coming year.
READ ALSO: Women and wealth: How to build a more prosperous future
Over the past three years, risk-based assets have produced robust returns. Market lift can increase risk in a portfolio by changing the asset allocation. This can happen knowingly, or sometimes, unknowingly. For example, if you had a 60% stock and 40% bond portfolio at the beginning of 2019, today, with no rebalancing, your allocation would have drifted to 72% stocks and 28% bonds. The risk profile of the portfolio has changed.
Now is a good time to review your financial plan and reassess your goals and objectives. By understanding the risk profile of your portfolio, you can rebalance accordingly to manage that risk.
Rebalancing is an important concept in portfolio management. And, when managing a taxable portfolio, tax loss harvesting can be an equally important concept. Throughout the year, trading activity is typically required in order to rebalance the portfolio and to raise cash for distributions. These activities can result in realization of taxable capital gains. In addition, many mutual funds distribute a capital gain at the end of the year.
As capital gains accumulate throughout the year, it’s important to review your portfolio for positions trading at a loss. “Harvesting” those losses in order to offset gains has economic value and can optimize your after-tax returns. If you maintain conviction to the asset and still want exposure to it in your portfolio, you can add it back to the portfolio after 31 days in order to avoid the wash-sale rule.
Manage Mutual Fund Capital Gain Distributions
A key to portfolio management is avoiding surprises. While actively managed mutual funds can be effective tools for capturing exposure to particular asset classes with the expertise and risk controls provided by professional money managers, one of the drawbacks of actively managed mutual funds is that they are required to distribute capital gains realized throughout the year to their fund shareholders.
There are a few activities that can help you navigate these distributions and assist in avoiding tax surprises. Keep an eye on communication from the fund companies you own in your portfolio. Typically, starting in October, fund companies publish estimated year end capital gain distributions and the dates associated with those distributions. Knowing this information as early as possible will help to determine if any actions can be taken in light of the distribution. Depending on the capital gains implications of selling the fund, it may be wise to do so before the record date of the distribution.
Plan for Next Year’s Expenses
For investors who have benefited from the rise in the market in 2021, it’s important to look out to next year for anticipated expenses that can be immunized by raising cash now. Factor in the income and dividends your portfolio is expected to receive between now and your future expense and consider raising the rest of what you will need by trimming or selling assets. If capital gains are a consideration, splitting the sales between the end of 2021 and the beginning of 2022 could be an effective strategy.
As the saying goes, “a bird in the hand is worth two in the bush”. Trimming gains to raise cash now for a known expense in the future is a wise way to lock in gains and remove the risk of selling assets at a lower level if the market experiences volatility between now and the time of the expense.
Taking some time to accomplish a few simple tasks near the end of the year can have a tremendous effect on your portfolio over time. And executing these beneficial strategies within your portfolio will allow you to relax and enjoy the holidays with your family knowing that your portfolio is set up for success in 2022.
Mike Filing, CFP, ChFC, is associate director of portfolio management at UMB Bank.