Year-End Portfolio Prep

In mid-December, I generally take a little time with my portfolio to prepare for the year's end and line myself up for success next year. There are three primary areas I focus on: harvesting losses, rebalancing, and giving. Let’s have a look at each.

Harvesting gold from losses

Every year, there are stocks in my portfolio which went the wrong way and are now below my purchase price, dragging down my returns and putting red on my statements. It’s normal, it happens every year, and you should expect it of at least say, 30% of your stock picks. But there is one thing you can do to make lemonade from the lemons: you can harvest the loss on your taxes.

All that means is selling the negative position. You’ve then “realized” the loss—remember, stock moves are not taxable events until you sell them for a loss or a gain; all your returns are virtual until you sell. That loss will show up on your tax returns and will offset gains you’ve made elsewhere, both from assets sold for a profit and from regular income. So let’s say you have a stock which you bought for $1,000 which is only worth $600. If you sell by the end of the year, you’ll get $600 (minus trading costs), and the $400 you lost on that investment can be subtracted from your taxable income for that year, which reduces your overall tax bill. There’s no downside, and no catch.

There are, however, two limitations to careful of. The first is that you are restricted to a total of $3,000 in losses against your tax bill. Anything you sell beyond that amount of loss will be disallowed from offsetting your gains (but you can see your CPA about forwarding the loss in later years). The second is called the “wash-sale rule.” Basically, if you sell an asset for a loss and then repurchase the same asset or a nearly identical asset within 30 days, the IRS will disallow the loss. So make sure that, if you harvest a loss on a stock you like and intend to repurchase, you wait a month first. Details on tax loss harvesting can be found here and here.

Another useful annual ritual (I actually do this continually through the year) is a rebalancing of the assets you hold to realign your portfolio with your goals and risk tolerance going forward. The idea is to buy or sell equities specifically to reestablish the asset balance you intended to hold (stocks to bonds to gold, or technology to banking to pharmaceuticals). So if during the year you cashed in or sold a few bonds, and you are now theoretically underweighted in bonds, you would buy some to balance the scales. Or if one tech stock in particular rose dramatically this year (AMZN, NFLX), hypothetically you now hold more technology than you intended (and you have categorically more risk from having so much tied up with just one stock). So you would sell some off, or buy another asset to offset the tech you hold. If you’re not a regular buyer (and if you're reading this I hope you’re not a regular trader), and in fact you don’t look at the portfolio terribly often, rebalancing is good practice to ensure proper a comfortable and adequate allocation in your basket of assets. It will also help you to sleep better. Two great articles and some depth about rebalancing can be found here and here. 

Finally, I like to spend some time with my family choosing and giving to charities at the close of each year. When most people give to a non-profit, for the sake of simplicity they write a check or just put the gift amount on a credit card online. But did you know that many non-profits, particularly larger ones with more developed infrastructure and staff, accept gifts of stock directly? 

If you sell a stock during the year which has risen since your purchase, you’ll pay gains taxes on the sale. You can then use the proceeds from that sale to buy another stock, to pay for a trip or your children’s tuition or just to go shopping. If you use those proceeds for charitable giving, you’ve just paid capital gains tax on money you intend to give away, making your gift that much more expensive. You can still write off the dollar value of the charitable gift itself, but only that amount.

charity: water

If instead you give a non-profit an appreciated stock directly, you’ll pay no gains tax (you didn’t sell it, so you never realized the gain) and you can deduct the entire value of that stock from your taxable income. In other words, depending on your gains tax rate, most of us would save 15% right there. The charity gets a larger total amount, albeit in the form of a stock. And they can choose to hold those stock shares for future gains, or sell it themselves and pay no taxes. (For more on 2015 capital gains tax rates, look at this.)

So take a few minutes this weekend to look things over and make sure your assets are where you want them to be before the tax year closes. A little minor tinkering can save money and headaches later, and put you on the right road going into the new year.

Drifting to Fifty | Random unrelated nugget of the week

Don't fret over those sloppy holiday party guests: Mayonnaise spread thick on a wooden table over a condensation ring will absorb the moisture, clearing the ring. But it will happen slowly.