Plan Now for a Year-End Investment Review

You might not enjoy sitting down to do year-end
investment planning, but at least this fall you
can make plans with greater certainty. For the
last three years, investment planning has
meant trying to anticipate possible changes in
tax law; for tax year 2013 and beyond, you
know for sure how income, capital gains, and
qualifying dividends will be taxed. That gives
you an opportunity to fine-tune your long-term
planning, or to develop a plan if you’ve
postponed doing so. Here are some factors to
keep in mind as the year winds down.
Consider harvesting your losses
With tax rates settled, the question of whether
to sell losing positions to generate capital
losses that can potentially be used to offset
capital gains or $3,000 of your ordinary income
becomes a much more straightforward
decision. That process is known as harvesting
tax losses, and it could prove especially worth
considering this year. The first half of the year
produced strong gains for U.S. equities; even a
mediocre second half could still have the
potential to leave you with a higher tax bill than
you had anticipated.
To maximize your losses for tax purposes, you
would sell shares that have lost the most, which
would enable you to offset more gains. Unless
you specify which shares of stock are to be
sold, your broker will typically treat them as sold
based on the FIFO (first in, first out) method,
meaning that the first shares bought are
considered to be the first shares sold. However,
you can designate specific shares as the ones
sold or direct your broker to use a different
method, such as LIFO (last in, first out) or
highest in, first out.
Interest rates: bane or blessing?
The Federal Reserve has said that if the
economy continues to recover at its expected
pace, it could raise its target Fed funds rate
sometime in 2014. However, investors have
been anticipating such an increase since early
summer, when many bond mutual funds began
seeing strong outflows from investors
concerned that a rate increase could hurt the
value of their holdings. As any consumer
knows, lower demand for a product often
means lower prices. And since bond prices
move in the opposite direction from bond yields,
yields on a variety of fixed-income investments
have begun to rise. However, there also could
be a silver lining for some investors. Higher
yields could provide welcome relief for
individuals who rely on their investments for
income and have suffered from rock-bottom
The Fed has said any rate decisions will
depend on future economic data. However,
now might be a good time to assess the value
of any fixed-income investments you hold, and
make sure you understand how your portfolio
might respond to a future that could include
higher interest rates. Many investors’ asset
allocation strategies were likely developed
when conditions generally favored bonds, as
they have for much of the last 20 years. Though
asset allocation alone can’t guarantee a profit
or prevent the possibility of loss, make sure
your asset allocation is still appropriate for your
circumstances as well as the current investing
climate. And don’t forget that other financial
assets can be affected by potential future
interest rate changes as well.
Calculating cost basis for fixed-income
The IRS had originally planned to require
brokers to begin reporting the cost basis for any
sales of bonds and options this year, as it
already does for stocks and mutual funds. It
has now postponed implementation of the
requirements for bonds until January 1, 2014 to
give financial institutions more time to test their
reporting systems. However, don’t throw away
your old records yet, especially if you’re
considering selling any of your bond holdings.
The cost basis reporting requirements will apply
only to bond purchases and options granted or
acquired on or after January 1, 2014, so you’ll
still be responsible for calculating your cost
basis for any bonds or options acquired before
that date.