Does your investment portfolio need to be serviced? Just like your car, your portfolio may need a "tune-up." Year-end is a great time to review your portfolio to ensure it is operating at optimal levels.

As we move closer to year-end, you may want to review the asset allocation and investment mix of your portfolio. It is also the perfect time to consider tax minimizing strategies and charitable gifting. 

Portfolio Alignment

Proper tire alignment is vital to avoid excessive wear on tires and vehicle parts. Over time, if your car gets out of alignment, it may start to pull you in a certain direction. This makes it hard for you to stay straight on the road.

Much like a car, your portfolio may need an alignment. This typically happens due to different investment performances over time between asset classes, such as stocks and bonds. For example, if you are a hands-off investor who positioned your portfolio five years ago to be 50% stocks and 50% bonds, you may now be over 60% stocks. As a result, your portfolio is much different than you intended and will likely have a different risk profile. By rebalancing to your target asset allocation, you are able to address the risk/reward characteristics of the portfolio. Doing so may help you avoid taking unnecessary risks that could steer you off your “path” and potentially into a ditch. 

Minimize Tax as Rebalance

As you rebalance, you want to start with looking at any tax-sheltered accounts such as IRAs and 401(k)s. You can sell and reinvest in retirement accounts without income tax consequences. However, this is not the case with your non-retirement accounts. 

Tax Loss Harvesting. To minimize any tax consequences in your regular brokerage accounts, if you sell a security that creates a gain, you should attempt to offset it by selling a security with a loss. Go through your non-retirement investment accounts and look for securities that are valued less than what you paid for them. Selling these securities will create capital losses that can be used to reduce any gains you have created as well as up to $3,000 of ordinary income.

Charity Gifting. If realigning to achieve the appropriate asset allocation requires you to reduce your equity holdings, you may want to consider gifting individual stock or stock mutual funds as part of your strategy. Instead of gifting cash to the charity, consider gifting appreciated securities. You receive a charitable deduction for the fair market value of the stock or mutual fund units and you avoid the capital gain tax.  It is not advantageous to gift a security with a loss.  It is better to sell an underperforming security and take the loss on your tax return as mentioned above. 

Maintenance Check

To keep your car functioning at its maximum potential, it is important to perform routine maintenance.  If you neglect performing the necessary car service, it can cost you hundreds of dollars later on. Many investors display the same negligence as they fail to review their investments from time to time.  

Your investment portfolio maintenance should start by looking at your individual holdings and comparing them to the appropriate performance benchmarks to see how they match up. This should help identify parts of your portfolio that may need a change or that you want to start monitoring more closely.

In addition to the return performance of your individual investments, you should be aware of the transaction costs, internal expenses of mutual funds, as well as any management fees you are paying. However, while expenses are important to monitor to ensure they are within the reasonable range, net return is what should drive your investment decisions.

Timing of Purchase. If you need to purchase mutual funds to replace under-performing securities, be careful to time the purchases appropriately. Each year, a mutual fund is required to distribute to its unit owners the capital gain created by the sale of securities within the fund. The owner must pay tax on this capital gain distribution, even if the proceeds are reinvested in the mutual fund. This distribution usually occurs in the months of November and December.  If you plan to purchase units of the mutual fund in the fourth quarter, you should make your purchase after this distribution is made to avoid paying tax on your principal investment.

Summary

Although investors should take a long term view on their investment portfolios, much like cars, portfolios need to be serviced from time to time. Investors should rebalance their portfolio when it needs an alignment as well as periodically review the individual holdings. By dedicating some time to performing routine maintenance checks, you are likely to ensure your portfolio is operating at its maximum potential.

Anthony Bykovsky, CFA, an Associate Portfolio Manager at Bedel Financial Consulting, contributed to this article.

Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, “Your Money” segment.  Elaine’s book, “Advice You Never Asked For…But wished you had,” is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at ebedel@bedelfinancial.com.

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