Asset mix is a key feature of portfolio diversification. This assumes that various assets react differently to economic conditions. What’s good for stocks may be bad for bonds and vice-versa. By having a diverse portfolio, risk can be reduced and potential for profit can increase.
Rebalance
The recession has weighed heavily on the stock market, pushing prices down and skewing the portfolio’s ratio of stocks to bonds away from initial portfolio benchmarks. The end of the year is a perfect time to rebalance. This can be done in several ways. More cash can be added to the underweighted asset class, assets in the overweighted assets can be sold or the losers can be sold with the proceeds of the sale reinvested in new, better quality assets that are not “substantially identical” according to Internal Revenue Service rules.
Tax Loss Selling
This is hard for most investors as it involves admitting mistakes. While it won’t recover losses incurred during this year, it may soften the blow and offer a tax break as well. A realized loss in asset A can be used to offset a realized gain in asset B, leaving no capital gain liability. A loss can also offset capital gains liability incurred from a mutual fund distribution. The IRS allows a maximum loss of $3,000 per year. Losses above that amount can be carried forward and applied to capital gains until the loss has been exhausted.
IRA Re-Characterization
For those earning less than $100,000, consider switching from a traditional IRA to a Roth IRA. Traditional IRAs are tax-deferred accounts; contributions aren’t taxed but withdrawals are taxed at ordinary income rates. Roth IRAs are tax-exempt; contributions are taxed but withdrawals, including capital gains, are tax free.
If a traditional IRA was converted earlier this year into a Roth and the account has suffered even more losses, the IRS allows a re-characterization back to a traditional IRA, erasing the conversion and taxes owed on the earlier, higher value. After a 30 day period, the IRS will allow a re-conversion to a Roth, possibly at a lower asset price.
Required Minimum Distribution
Current law requires those over 70 1/2 years of age to take an IRA distribution calculated on age and life expectancy by December 31 and pay taxes on that distribution. Pending legislation in Congress may suspend the RMD for 2008 and 2009, removing the insult to an already injured retirement fund. Additionally, legislation to raise the age to 75 years from 70-1/2 may offer seniors some relief, allowing funds to recover instead of forcing a sale at greatly depressed prices.
Charitable Donations
A provision included in the Emergency Economic Stabilization Act of 2008 allows individuals aged 70½ and older to donate up to $100,000 from their Individual Retirement Accounts (IRAs) and Roth IRAs to public charities without having to count the distributions as taxable income. Do a good deed and get a tax benefit, but do it by December 31, 2008 to be eligible for the tax break.
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