Many “experts” are urging investors to re-position their portfolios for tax changes that may happen in 2013. These changes are part of the “fiscal cliff” — the mix of tax hikes and spending cuts that will take effect Jan 1 unless politicians compromise on a different set of laws. I would urge you to tune out this noise, and focus instead on tried-and-true ways to minimize the tax bite on your investments.
There are four reliable strategies to minimize tax on your investments:
- Max out contributions to your 401(k), 403(b), IRA and other tax-preferred accounts. You will defer tax up-front on most of these plans and delay paying tax on any gains for years or decades.
- Minimize trading, which minimizes taxable gains. If you buy mutual funds, select funds that have low annual turnover (20% or less), so the fund manager is not constantly generating taxable gains and sticking you with the tax bill when you didn’t even sell your shares in the fund.
- “Locate” your investments strategically. If your money is split between a retirement plan like a 401(k) and a taxable brokerage account, put the investments likely to generate more tax (like bonds or commodities) in your tax-deferred account, and investments likely to generate less tax (like long-term stock holdings) in your taxable account.
- Harvest your losses. If you sell and generate losses in a year, try to balance it out with gains. That doesn’t mean to sell something you don’t want to sell, but it does mean you can sell it without taking as big a tax hit.
The only reason you should re-jigger your investments to anticipate potential tax law changes is if you were going to do it anyway, and you’re taking a “bet” that it’s better to do it in Dec 2012 instead of Jan 2013.
Otherwise, follow the “boring” strategies that have helped smart investors manage their tax bill for decades … and leave prognosticating to the media.