With the economy showing signs of life and the
topping 10,000, it's tough not to rush to your portfolio and try to wring all the good news you can out of it. Resist that urge.
That's not to say some tweaking isn't in order -- you'll certainly need to rebalance, if nothing else. But your approach to your portfolio should be as circumspect in good times (or at least better times) as it is in bad times.
"The tendency is always to think things are so dramatically different now, and there's a need to completely revamp your portfolio," says Glen Clemans, a financial adviser with Pearson Financial Group. "Every year people say 'this changes everything.' But that's rarely true. You need to step back, look at your plan. Review your asset allocation and determine if you're on track."
A good asset-allocation plan, after all, will inherently provide every investment with a hedge. And outside factors such as tax cuts might provide cause for some adjustments, but not a portfolio overhaul. (For more on structuring a good asset-allocation plan,
click here.) With that in mind, though, here are a few things you ought to consider.
Your portfolio is almost certainly out of whack given this year's run-up in equities -- particularly in technology. If you -- or your funds -- own a number of tech stocks that have more than doubled in price since January (
Research In Motion
, to name a few), you're likely considerably overweight in technology. Then it is time to trim it back to your initial allocation before disaster hits ... again.
President Bush's new tax law cut the tax rate for qualified stock dividends to a flat 15% (prior to this law, stock dividends were taxed at your ordinary income tax rate). This has prompted planners to essentially look at dividend-paying stocks as something of a new asset class -- one that investors would do well to carve out a place for in their asset-allocation plan. "Not only does the reduced tax rate make the dividends more attractive," says Birmingham, Ala., financial adviser Stewart Welch III, "but the greater interest in these stocks will benefit the share price."
Welch recommends that of whatever allocation you've devoted to equities, some 60% of that should be in dividend-paying stocks. (The remainder can be spread among various sectors to capture returns among more aggressive stocks.) Welch looks for solid companies that generally pay upwards of 2.5% -- favorites include
, which pays 4.3%;
, which pays 3.2%; and
, which pays 2.4%.
Taking stock ... and moving it.
To take full advantage of the break on corporate dividends, you'd ideally hold all dividend-paying stock in a taxable account -- since dividends garnered in a tax-advantaged account don't incur any tax at all until you withdraw the money, at which point it's all taxed as ordinary income.
Also, since the yields offered by bonds and real estate investment trusts are
considered qualified dividends, those securities are best off in a tax-advantaged account. That way you won't owe
tax on the income received until you withdraw it from the 401(k), IRA or other tax-advantaged vehicle.
But before you engage in a flurry of buying and selling, remember that taxes should never be the sole motivating factor of investment decisions. That's especially true if you're talking about a tax law that's set to expire in four years, as this one is. "If you're a few years away from retirement, this strategy might make more sense," says Sophie Beckmann, a financial planner with A.G. Edwards. "But for younger people, the cons probably outweigh the pros."
So take some time to evaluate your options. If you're happy with your taxable bond fund, and your 401(k) plan doesn't offer a comparable option, you'll likely suffer from the switch. And don't forget about how quickly trading costs can multiply, as well as any back-end sales loads or tax consequences you'll incur from selling. Any one of these factors could mitigate or even negate any benefit you'd receive come tax time.
Timing is everything.
Mutual funds are required to "distribute" at least 90% of the capital gains they've realized during the 12 months ended Oct. 31 -- and that's taxable income to the fund investor. (Even when a fund has done poorly overall, it often sells enough stock at a profit that an investor will owe tax.) That distribution is generally made in December, and the worst possible time to buy into a new fund is just before it makes its distribution.
"You don't want to inherit a tax liability that's due to gains you didn't participate in," says Stephen Cohn, co-president of the Sage Financial Group. You won't have received any of the upside from the gains -- which were reaped throughout the year -- but you will still owe tax on them. So before investing in a new fund, check with the company to see when it makes its distribution.