The arrival of the year-end holiday season is a reminder that it is also time for investors to consider their ... taxes.
Bah humbug, you say?
Yet, millions of investors in mutual funds and individual securities could save substantial amounts of money by doing a bit of financial planning before year's end, say tax and financial experts.
Most small investors should consider the following four steps:
*Re-evaluate your investment plan.
"Investors might want to start just by taking a hard look at their asset allocation," says John Gardner, senior manager for financial planning at accounting firm KPMG LLP, in Washington. "Given the huge gains in equities the past several years, an investor's original mix of stocks, bonds, and cash holdings may have changed sharply, as the value of equities has appreciated sharply."
That may mean some investors are now top heavy with stocks, rendering their portfolios more "vulnerable to market downturns," Mr. Gardner says.
The rise of the stock market also might mean investors have incurred large gains by selling equities or stock mutual funds this year. If so, sell some some of your poorly performing equities or funds before the end of the year. Those losses will help offset the gains and lower your tax bill.
*Boost retirement contributions.
If you have a tax-deferred retirement plan, such as a 401(k) or 403(b), contribute as much as you can up to the maximum level allowed by Dec. 31, says Gardner. Such a move could help get you into a lower tax bracket.
*Know the ex-dividend date.
Investors should also be wary of buying into a new mutual fund now, before the fund has declared its annual capital-gains distribution. If you buy into the fund before the distribution date, you could be stuck with the entire year's worth of gains, even though you have just bought into the fund.
So, if you have a hankering to invest in a fund now, first call the fund and find out its "ex-dividend date." Once you've done that, wait until the date has passed before investing, Gardner says.
*Consider tax-managed funds.
These funds are designed to minimize the tax burden on investors, especially those in higher tax brackets, experts say.
Strategies include realizing losses within the portfolio whenever possible to offset gains; avoiding turnover of securities to avoid realized gains; penalizing shareholders for redeeming shares before a set period, such as five years. Redemptions, after all, can require a fund manager to sell some securities, which could trigger more realized gains.
Currently, there are at least 39 tax-managed funds, up from just a handful in the mid-1990s. Most large fund families offer them. Well known funds include the Vanguard Tax Managed Growth & Income Fund (800-662-7447), Vanguard Tax Managed Capital Appreciation Fund, Eaton Vance Tax Managed Growth Fund (800-225-6265), and Schwab 1000 (800-435-4000).
The track record of tax-managed funds as a whole, however, has not been stellar, compared to average US diversified stock funds.
According to Morningstar Inc., an investment information-firm in Chicago, the current roster of 39 tax-managed funds produced an average tax-adjusted return of 22.9 percent for the 12-month period through Oct. 31. The average US diversified mutual fund generated a 24.4 percent return for that same period.
But over time, tax-managed funds look better. For the three-year period ending Oct. 31, they posted an average return of 19.6 percent, compared to 15.1 percent for US diversified funds. During that period, however, there were only 10 tax-managed funds.
If an investor is reluctant to buy into a tax-managed fund, they could consider an index fund, which tends to have relatively low turnover, says Gerald Perritt, editor of the Mutual Fund Letter, based in Largo, Fla.
For the mutual fund industry as a whole, "the turnover rate has soared in recent years, now well over 80 percent for the typical equity fund," Mr. Perritt says.
Another obvious way to offset taxes on realized gains from a mutual fund, Perritt says, is to do what many individual investors are now doing: shifting some of their dollars to direct holdings of securities.
Besides getting "bragging rights" when one of your stocks soars in value, you also control when that security will be sold. If you don't sell, you can't be saddled with a capital gain, Perritt says.
(c) Copyright 1999. The Christian Science Publishing Society