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Time to Consider Year-End Investment Moves

Taking time now to make some strategic saving and investing decisions before December 31 can affect not only your ability to meet your financial goals but also next April's tax bill.

Review and rebalance

A review of your portfolio can tell you whether it's time to rebalance. If one type of investment has done well, it might now represent a greater share of your assets than you originally intended. To rebalance, you could sell some of that asset class and use the proceeds to buy other types of investments that will bring your overall allocation back to an appropriate balance. Diversification and asset allocation don't guarantee a profit or protect against a possible loss, of course, but they're worth reviewing at least once a year. Your checkup also can help you decide whether it makes sense from a tax perspective to do that rebalancing before or after December 31.

Consider harvesting losses

It's also a good time to consider the tax consequences of any capital gains or losses you've experienced this year. Though tax considerations shouldn't be the primary driver of your investing decisions, you can take steps before the end of the year to help manage your taxes.

If you have realized capital gains and you have no tax losses carried forward from previous years, you can sell losing positions--known as harvesting losses--to offset some or all of those gains. Any losses over and above the amount of your gains generally can be used to offset up to $3,000 of ordinary income ($1,500 for a married person filing separately) or carried forward to offset future gains.

Before selling an investment, consider how long you've owned it. Assets held a year or less generate short-term capital gains and are taxed as ordinary income. That tax rate could be as high as 35%, not including state taxes. Long-term capital gains on the sale of assets held for more than a year generally are taxed at lower rates: 15% for most investors, 0% to the extent investors are in the 10% and 15% tax brackets (through 2010).

Time trades carefully

If you're selling to harvest losses and intend to repurchase the same security, make sure you wait at least 31 days before buying it again. Otherwise, the trade is considered a "wash sale," and the tax loss will be disallowed. The wash sale rule also applies if you buy an option, sell a stock short, or buy it through your spouse within 30 days before or after a sale of the same security.

If you're considering purchasing a mutual fund outside of a tax-advantaged account, find out when the fund will distribute dividends or capital gains. Consider postponing action until after that date, which is often near year end. If you buy just before the distribution, you'll face potential taxes on that money, even if your own shares haven't appreciated. If you plan to sell a fund, you may be able to minimize taxes by doing so before the distribution date.

Think about your cost basis

If you own a stock, fund, or ETF and decide to unload some shares, you may be able to maximize your tax advantage. There are several ways to figure your cost basis; for example, you can use the average cost per share for a mutual fund. Or you could request that specific shares be sold--for example, those bought at a certain price. Which shares you choose depends on whether you want to book capital losses to offset gains, or keep gains to a minimum to reduce your tax bite (this applies only to shares held in a taxable account.)

Taking a moment out of the holiday rush to plan ahead could be a big help in the spring.

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