As 2011 winds down and we prepare for 2012, it is important for all investors to review their investments and consider making some adjustments. Let’s consider the most important steps to take:
1) You have one more trading day to harvest investment losses from 2011, which could reduce your income tax liability for 2011 (reduce your dividends and capital gains, dollar for dollar; any investment losses which exceed investment income can be taken as a loss against taxable income, up to $3,000; and unused balanced is carried into 2012).
2) As you review your investment returns this year, do so by asset class (such as treasury notes or bonds), corporate bonds, domestic equity (large cap, mid cap, or small cap), international equities (developed or emerging markets). Many experts advise investors to “re-balance” at least once a year. There are too many different ways to re-balance your investments to cover all of them here. The basic premise is this:
a. Sell enough positions from asset classes which have done well (such as treasury notes/bonds) to reduce the remaining balance to the level at which it stood early in 2011.
b. Take those funds and add to your more poorly performing asset classes.
This process can prove challenging for investors, since it is counter-intuitive to “cut short” your successes and add to your poor performers. However, re-balancing is a time-tested method to maximize your return over time! The explanation is simple. Investment performance is cyclical – outperformance by one class in a given year is generally followed by underperformance in a following year… and vice versa.
3) If you have not done so yet, a universally recommended strategy for maximizing savings and investment return is to contribute the full, allowable amount to your employer provided 401(k) plan. The money will grow tax-free inside the account until withdrawn, thereby giving you a tremendous advantage over taxable investments. If you are under the age of 50, you can defer up to $17,000 during 2012 in such a plan. If you will be 50 by 12/31/12, you can add an additional $5,500! If you do not have access to a 401(k) plan, an IRA provides the same tax deferred benefit for investments. For those up to 50, $5,000 is allowed for 2012, with an extra $1,000 allowed for those over 50. AND, if you haven’t contributed yet in 2011, you have until the day you file your 2011 tax return (up to April 17) to create or add to an IRA.
4) Speaking of IRAs, if you have an existing IRA and you turned 70.5 years old during 2011, you only have until April to withdraw your annual Required Minimum Distribution (RMD). You can easily find the formula for calculating your RMD by searching on the web. It is absolutely essential to remember to withdraw your RMD on time – because the penalty for not doing so is 50% of the amount you should have withdrawn, PLUS the normal income tax due on the withdrawal!
I wish you a safe and Happy New Year… and great success in your investing throughout 2012!