Year end investment planning – the tax puzzle

Year end investment planning – the tax puzzle

It’s fast approaching the end of the year and I’m getting calls from clients “Should I sell this stock at a loss to offset gains in my portfolio? What can I do to minimize my taxes? Should I invest in a municipal bond for tax free yield?”

While all of these questions are intelligent questions to be asking, as saving money on taxes equals more money in your pocket, I feel like many investors lose their reasoning capability when it comes to the issue of taxes and investments. Many clients start asking the question “How do I minimize my taxable liability?” when they should be asking “How do I maximize my investment return?”

So to answer the first 3 questions posed I responded:

1.       Should I sell this stock at a loss to offset gains in my portfolio?

Answer: The stock is either a good investment or a bad investment. If it is a good stock to own that you believe will grow and provide you an adequate return, hold on to it. If the stock is no longer a valuable investment, sell it. Taxes are not the primary mover of investment decisions.

2.       What can I do to minimize taxes?

Answer: Great Question! Here we can do an investment review to see if any of the stocks with a loss year to date happen to be a poor investment and sell them to purchase a better investment. The result of this will be a tax offset. Also, consider funding your IRA or Roth if the money is to be used for retirement.

3.       Should I invest in a municipal bond for tax free yield?

Answer: It depends on the tax equivalent yield between a municipal bond and a corporate bond (another factor is the ability of the borrower to repay, but for this illustration we’ll assume they have the same default rate!) and therefore is a fairly simple math problem. If the corporate bond pays 8% and you have to pay a 15% tax on your dividend you will actually yield 6.8%. If the municipal pays a tax free yield that is greater the 6.8% buy the Muni. If it pays less, buy the corporate.

The lesson to take away is that the primary goal of investments is total rate of return. Minimizing taxes is a key aspect in getting the highest possible return, but is certainly not the point of the investment.



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