What Investors Need to Know About Tax Loss Harvesting

Selling stocks at a loss can be a tough decision to make: no one wants to admit that they made a bad investment. Come tax time, however, strategically realized losses can help lower your capital gains tax liability, thanks to a strategy known as tax loss harvesting.

With tax loss harvesting, an investor sells a security at a loss, and by realizing that loss, offsets some of the taxable gains from the same year. The investor then typically replaces the security they sold with a similar one, in order to  remain in line with their target asset allocation, while taking care to avoid wash sales.

“It makes sense if you have a lot of short term gains,” says Mark Tan, a financial advisor at Thrivent Financial.


Higher earners benefit more

Investors in higher income tax brackets see more benefit from tax loss harvesting, as they typically have a higher capital gains tax rate and have more liquid assets to invest.

According to Aaron Gubin, head of research at SigFig, this strategy is most beneficial for investors who have taxable accounts exceeding $100,000 and make reasonably large, continual deposits throughout the year.

That’s because any time an investor sells a stock to realize a loss, they effectively reset their cost basis to a lower level. In order to perform tax loss harvesting again, that investor should purchase stocks at a higher price in the future, and then sell again at a loss further down the road, to offset the gains. (If it sounds complicated, it can be. Investors considering this strategy should consult with a tax or accounting professional for advice pertaining to their specific situation.)

According to SigFig data, 26% of investors with portfolio values between $250,000 and $1 million engaged in behavior indicating possible tax loss harvesting in 2014 (they executed 30% or more of their annual trades in December). Among investors with portfolio under $250,000, only 11% engaged in this type of behavior.


Think of tax-loss harvesting as an year-round strategy

Many investors engage in tax loss harvesting at the end of the year, but it should really be a year-round strategy, according to John Sweeney, executive vice president of planning and advisory services for Fidelity Personal and Workplace Investing. “There is market volatility all year that presents opportunities,” he says.

However, investors should be aware of the costs, such as transaction fees incurred when making trades, or redemption fees charged by some funds if a position is eliminated during a holding period.

Additionally, wash sale rules prevent investors from claiming a loss on a security, if they end up buying it again within 30 days of selling it.

At the end of the day, while tax events matter, investors should not make moves solely for the sake of reducing their taxes. Selling a stock at a loss just to offset gains means you might miss out on appreciation in the future. “Don’t let the tax tail wag the investment dog,” says Sweeney. “Make your investment decision first, and think about the tax consequence second.”

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

How to Strike a Balance with Portfolio Rebalancing

Portfolio rebalancing is a topic investors come across often. The advice may vary depending on whom you ask, but most financial advisors tend to touch on two main issues: how often to rebalance and when.

Equally important is when and why not to rebalance. Rebalancing is a strategy to maintain one’s asset allocation in line, should significant market swings or dividend payments affect it. It should not be a knee-jerk or emotional reaction to every market move, and it should most definitely not be done in the pursuit of the next hot investment opportunity.

“Rebalancing won’t increase the rate of return,” says Michael Brady, founder and president of Generosity Wealth Management in Boulder, Colo. “The purpose of rebalancing is to stick with the plan.”

Not only might overly frequent rebalancing increase investment costs, but it also risks cutting off a cycle before it runs its course, Brady explains. “Whether the cycle is multiple quarters or multiple years, you’ll never catch the upward cycle if you are always shifting away from the downside,” he says. Not to mention that rebalancing could create a tax situation if it causes short-term realized gains.

Is rebalancing necessary?

When it comes to rebalancing, there are two schools of thought. Some investors avoid rebalancing entirely. “I don’t think there is any great data out there that says investors need to do it at a particular interval,” says Jeff Tjornehoj, a senior research analyst at Lipper. “Both [stock and bond] markets tend to perform well over time, with stocks moving up and bonds producing income,” he explains. “Non-balancing is a hands-off approach.”

Others argue that rebalancing forces you to pay attention to and understand your portfolio. “If you don’t rebalance, you end up having a lopsided portfolio,” says John Piershale, wealth advisor at Piershale Financial Group.

Rebalancing strategies

1. Calendar rebalancing
This is the most common rebalancing strategy among everyday investors. With calendar rebalancing, an investor picks a time interval to review their portfolio and make adjustments, if needed, to get investments back in line with their original allocation. Calendar rebalancing can happen quarterly, yearly, or once every few years. For average investors, Brady says rebalancing on an annual basis is sufficient to prevent the portfolio from deviating too far from the original plan.

2. Asset class rebalancing
In a properly diversified portfolio, the investor’s assets are spread among several asset classes. An appropriate time to rebalance is when one or more of those asset classes’ share of the portfolio deviates by a wide enough range.

For example, say your ideal stock-bond allocation is roughly two-thirds in stocks and a third in bonds. But in a year, the stock market rises 20% and bonds fall 20%. This would bring your allocation to ¾ stock and ¼ bonds: a much riskier portfolio than where you started. Rebalancing will take care of the deviations from your ideal portfolio by buying when prices are low and selling when prices are high, says Aaron Gubin, director of research and wealth management at SigFig.

3. Glide path rebalancing
Glide path rebalancing is essentially the strategy of target-date funds. The portfolio’s asset allocation is determined with a specific retirement date in mind, and becomes more conservative as this date approaches.

With many people living thirty years or longer in retirement, glide path rebalancing can also play a role in making sure the investment portfolio is generating decent returns, while protecting their savings. For instance, Brady says an investor might have 40% of their portfolio in equities in the first ten years of retirement, then pare their equity position down to 30% in the second ten years, and 5% for the remainder of their lifetime.

Rebalance for the right reasons

At the end of the day, rebalancing should be about keeping your investments in line with your investment goals and strategy. Whether you do it based on a predetermined time or age, the key is to make sure it keeps you on track with your plan.

Be tax- and cost-efficient

One of the strongest arguments against frequent rebalancing is that, much like with market timing, the investor is likely to incur trading costs, and possibly trigger short-term capital gains if they sell assets held less than a year. One way to rebalance with taxes and costs in mind is to utilize cash dividends and fresh cash deposits to do “sale-free” rebalancing, says Gubin. “We spend fresh cash on the most underweight security to bring it back up to its target weight, without having to sell assets that are overweight,” he explains. “This is tax- and trading cost-efficient because we don’t have to sell anything, or execute unnecessary trades. We can buy assets with the new cash to keep client portfolios on track.”

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Traditional or Roth? How to Choose the Retirement Strategy for Your Situation

To save or not to save for retirement is not the question. For most investors, the question that matters is which retirement savings strategy is more beneficial: Roth IRA or traditional IRA.

With a Roth IRA or 401(k), the investor pays taxes on contributions, but once they are 59 ½ or older, account withdrawals, including any gains, are tax-free. With a traditional IRA or 401(k), the investor puts off paying taxes on contributions until they begin making withdrawals. At that time, however, they pay taxes on their contributions and account earnings.

Which strategy makes more sense depends on the investor’s tax bracket and earnings potential, but that does not mean they have to choose one over the other. Thanks to a handful of different strategies, savers can get the benefits of both pre-tax contributions and tax-free gains.

Basic Considerations: Current Income & Future Earnings Potential

When choosing between contributing to a Roth or traditional account, the biggest factors to consider are the income limits for IRAs, your tax bracket, and your future earning potential.

    • Income limits

Individual investors whose adjusted gross income (AGI) exceeds $71,000 (or $118,000 for married couples filing jointly) aren’t eligible to make tax-deductible IRA contributions. Individuals whose AGI is $61,000 or lower ($98,000 for married filing jointly) can take the full deduction for their IRA contributions in 2015.

There is one exception; investors who do not have an employer-sponsored retirement account at work qualify for tax-deductible contributions regardless of income.

    • Future earnings

Future earnings potential, on the other hand, plays a role choosing between Roth and traditional IRA options. A Roth IRA or 401(k) does not give you an upfront deduction, but the earnings grow and can be withdrawn tax-free. “Someone in an entry level job working on their MBA, who will have the opportunity to amass significant savings over time, is better off paying taxes upfront,” says Christine Benz, director of personal finance at Morningstar. But if you have already reached your peak earnings level and find yourself in a higher tax bracket than you believe you will be in upon retirement, the upfront deduction of a traditional IRA account may make more sense.

Mix and match to get the most out of an IRA

“If you put a thousand financial advisors in a room, [a third of them] will tell you to put everything in pre-tax [accounts] and a third will tell you to put it in a Roth. I’m in the camp [that says] do a little of both,” says Larry Rosenthal, a Certified Financial Planner and president of Rosenthal Wealth Management Group.

Additionally, as your tax bracket and income can change over time, so too should the way you save for retirement.

Most people in the 25-to-35 year age range are typically on the lower side of their potential earnings and may benefit from a Roth IRA, says Rosenthal. The ideal time to begin saving in a traditional IRA is once an investor moves to a higher tax bracket (assuming they still qualify for the deduction), so they can take advantage of a bigger write-off.

401(k) considerations: Roth or Traditional

Increasingly, employers are beginning to offer a Roth option within their 401(k) plans. This can be a boon to investors who are phased out of Roth IRA contributions, but believe that their tax bracket will be higher in retirement. “The Roth 401(k) doesn’t have any income restrictions, so it’s a good way to get some tax-free growth if you can’t contribute to a Roth IRA,” says Robert Brokamp, senior advisor at The Motley Fool.


Backdoor IRA rollover

Roth IRAs have income eligibility requirements that may disqualify higher earners from contributing:

Roth IRA eligibility for 2015:

  • Individuals with AGI between $116,000 and $131,000 and married couples filing jointly who earn between $183,000 and $193,000 qualify for a reduced contribution.
  • Those with AGI higher than the upper limits above do not qualify for Roth contributions.

One way around those requirements is a backdoor Roth IRA. With this strategy, investors contribute to a traditional nondeductible IRA, which is available to anyone regardless of income, and then convert that to a Roth.
There is, however, a caveat to this strategy for investors who already have assets in a traditional or rollover IRA (with assets that have not yet been subject to taxation); the taxable portion of the conversion will be prorated over all IRA assets. In order to take advantage of the backdoor Roth conversion, the investor will need to convert all other IRA accounts to Roth. This may present an investor who has a large pre-tax IRA balance (including any rollover IRAs) with a sizable tax bill. Before taking any steps, it’s best to consult with a tax professional, such as a CPA.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Robo-Advisors Reduce the Cost of Investing

If you have recently researched investment management services, chances are that you have come across the term “robo-advisor.”

Who are these robo-advisors and can you trust them with your financial future?

A robo-advisor is an online investment platform that uses algorithms to determine asset allocations for investors and manages their investment dollars with minimal human intervention. Because it utilizes technology rather than active management by a human, robo-advisors charge significantly lower fees than what most financial advisors typically charge.

“It’s a fast growing business today, with something close to $20 billion in assets under management,” says David Larrabee, director at CFA Institute, the association of investment professionals. “Robo-advisors are here to stay and have demonstrated there is demand.”

According to recent research by A.T. Kearney, approximately $2 trillion will flow into robo-advisor platforms over the next five years.

Why Robo-Advisors

What is driving the explosive growth in the robo-advisor marketplace? Experts point to the demographics, account sizes, and low costs as the main factors.

Demographics: Investors of all ages are using robo-advisors, but not surprisingly, they are especially popular among millennials and Generation Xers who grew up with technology and would feel just as comfortable firing off an email or texting as they do talking to a human being.

Lower account minimums: Furthermore, most wealth management firms require investors to have a minimum of $100,000 or more in investable assets. Robo-advisors have investment minimums in the low four-digit numbers; some have none. “The traditional investment advisory accounts’ minimum of $100,000 puts these advisors out of reach for a lot of investors,” says Larrabee. “Robo-advisors are stepping up to fill that void.”

Lower fees: Last but not least, robo-advisors are inexpensive. While traditional wealth management services charge 1% of assets under management or more, the typical fee charged by a robo-advisor is 25 basis points or lower, depending on account size.

How Robo-Advisors Work

With a robo-advisor, clients open an account and typically start by answering a series of questions about their age, tolerance for risk, and investment goals. The platform provides an asset allocation based on their answers. An older investor nearing retirement, for example, will be recommended a more conservative asset allocation than a younger investor who will be working for decades to come.
Low-cost index investing keeps emotions out of your investment strategy

Robo-advisors typically do not trade individual stocks or offer specific stock trading advice. Rather, they tend to invest in low-cost ETFs, which provide instant diversification, as well as tax efficiency.

Most robo-advisors adhere to a buy-and-hold, passive investing strategy. They do not pick stocks or try to time the market. Instead, robo-advisors are charged with figuring out the exposure investors should have to stocks, bonds, international investments, and other asset classes, and use each individual investor’s age, expected retirement date, and risk profile to come up with an asset allocation and stick to it, regardless of day-to-day market movements.
Account rebalancing keeps your investment goals on track

Although robo-advisors do not react to stock movements, they do track the markets on a daily basis. If market swings move clients’ portfolios out of balance with respect to their recommended asset allocation, they rebalance accordingly, while being mindful of creating taxable events or incurring trading fees.

As a result, investors with these platforms do not have to get on the phone with their money manager if one company is driving an entire sector down. They can rest assured that, provided that they are in a properly diversified portfolio, they will be able to stay the course and ride out any market downturn.
Investors who need estate planning or have complex investment portfolios may want the hand-holding that comes with a financial advisor, or simply find a good lawyer and then choose low-cost index funds or ETFs on their own. For many investors, however, robo-advisors offer a way to grow their investment nest egg without getting hit with high costs and fees.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

REITs: A Way to Invest in Real Estate, Earn Income, Diversify

Investing in real estate isn’t only for property owners and speculators. Investors get can get the benefit of diversification and earn income by investing in a real estate investment trust, or REIT.

Around since the 1960s, REITs are publicly traded companies that invest in real estate either by purchasing property directly or by buying pools of residential and commercial mortgages. Unlike publicly traded companies, however, REITs are required by law to distribute 90 percent of their earnings to their shareholders in the form of dividend payments.

As a result, REITs become particularly attractive in a low-yield environment, where generating income from traditional investments can be challenging, says Robert Goldsborough, an analyst at Morningstar. “Investors are craving and hunting for yield anywhere they can find it,” he says.

High dividend payments also make REITs appealing to older investors, who typically focus on generating income as they approach retirement. According to SigFig data, the median age for investors who own REITs is 54, and investors older than 55 are nearly three times more likely to own REITs than investors age 35 or younger.


Perhaps even more important than income generation is the role REITs can play in portfolio diversification. Real estate is an asset class that doesn’t tend to move in the same direction, at the same time, as stocks and bonds, explains Aaron Gubin, director of research at SigFig. “By including REITs in your portfolio, you can reduce its overall volatility.”

Ways to Invest

Investors can buy shares in individual REITs, or invest in a REIT fund, which invests in a basket of publicly traded REIT companies. REITs themselves can invest in mortgages — which generate income to investors from the interest payments they collect — or in the equity of actual properties, which generate income from rent. Hybrid REITs invest in both.

Regardless of which type of REIT an investor chooses, they should be careful to choose the appropriate allocation. SigFig’s Gubin says the sweet spot is typically around 5 to 6 percent of overall holdings. If an investor’s REIT allocation is too low, it will have very little diversifying impact, he explains.

Risks, Tax Implications, Fees

As with almost any asset class, there are risks associated with investing in REITs. Depending on the type of REIT or REIT fund you select, rising interest rates could affect your return, says Goldsborough. Rates remain near historic lows, but many market observers expect that they may rise this year and into next year. That could impact REITs’ yields, making them less attractive for income-seeking investors, Goldsborough adds.

REITs’ dividend distributions can also cause taxable events, unless they are held in a tax-advantaged account like an IRA or 401(k). “Because they have high relative dividend payouts, you would prefer not to have REITs in your taxable accounts,” says Gubin.
Just like with any fund investment, investors should be aware of fees. If an investor takes a passive approach by purchasing a REIT ETF, Goldsborough recommends choosing one that tracks a well-constructed index. “You want to choose a REIT with very low fees and a significant amount of diversification,” he says.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.