Tax Law Shouldn't Alter Your Behavior

While politicians and pundits have been jabbering on about how good the new tax law will be for investors, financial planners are more circumspect, cautioning against many knee-jerk changes.

Tax law rarely prompts a radical shift in investing behavior. In 1997, when President Clinton eliminated all tax on home sale profits up to $500,000, alarmists predicted the housing market would collapse. But instead of dumping their homes and stuffing their tax-free profits into gold bullion or high-tech stocks, wealthy homeowners actually took their tax-free profits and ... bought bigger homes. Instead of collapsing, the housing market continued to flourish.

So it's unlikely that we'll see sweeping sea changes in how investors, well, invest. But that hasn't stemmed the tide of speculation and dubious advice as to how investors should deploy their assets.

Conventional wisdom dictates that investors hold the least tax-advantaged securities in the most tax-advantaged vehicles. That's why, historically, individual stocks were usually better held in taxable accounts, where they'd be subject to the 20% capital gains rate, while dividend-paying stocks and funds were better off in tax-advantaged accounts such as IRAs and 401(k)s, where the dividends would escape tax until the money was withdrawn.

But while it seems like the new, low 15% tax on capital gains and dividend payouts is cause for an allocation overhaul, don't make any rash decisions.

"If you had a reasoned asset allocation three weeks ago, chances are it will still work for you," says Glen Clemans, a financial planner in Portland, Ore. "First and foremost, you need to know your investment objectives. Tax considerations come behind that."

In other words, your portfolio allocation should be determined by your risk tolerance and time horizon -- not taxes. So if you've decided that your overall portfolio should be 30% bonds, there's no reason to move you're entire 401(k) into bonds. (Unless, of course, your 401(k) is 30% of your overall portfolio.)