A Year-End To-do List for Investors

By Christine Benz
Christine Benz
Christine Benz
November 23, 2014 Updated: November 25, 2014

Video Transcript

Christine Benz: Hi, I’m Christine Benz for Morningstar.com. As the year winds down, investors should have a few key items at the top of their to-do list. I recently chatted with Colleen Jaconetti, who focuses on financial planning for Vanguard, to discuss some of them.

Colleen, thank you so much for being here.

Colleen Jaconetti: Thank you for having me.

Benz: Year-end is fast approaching, and there are some financial planning to-dos that should be on people’s lists, particularly as they are thinking about their investment accounts. So, you’ve put together a good list of things that you think should be top of mind for investors as the year is winding down. The first is taking a look at the various tax-sheltered accounts that you might have available to you. Most of these do have a deadline of year-end. In the case of IRAs, you actually have until your tax-filing deadline. But let’s talk about how you should be thinking about these deadlines and also why you should be thinking about them as we get into the end of the year.

Jaconetti: I think people should really think about maximizing their tax-advantaged contributions because there is a limit each year. So, there are catch-up contributions down the road; but for the most part, making the most of these tax-advantaged opportunities really helps them to have the most that they could have at retirement. So, whether it’s a Traditional IRA or a Roth IRA, for self-employed people, maybe think about contributing to a SEPP IRA [Substantially Equal Periodic Payment IRA]. And then in addition, if people have college-saving needs, you could fund a 529 plan, and these will be after-tax contributions, similar to a Roth, tax-free growth. But some states actually give people a tax break.

So, with end of the year coming up quickly, it’s important to make sure for these contributions that you’re meeting all the deadlines because, again, if you miss the deadline, then you don’t get the tax benefit this year.

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Benz: And with IRAs, I mentioned that you actually have until your tax-filing deadline, but I’m guessing you’ll say people shouldn’t wait until that very last minute. Why should they not delay?

Jaconetti: So, it’s really because of the market performance. Hopefully, the market will be going up–7 out of 10 years the stock market does go up. So, by delaying, you’re actually just costing yourself growth on the portfolio.

Benz: As the year winds down, you say it’s also important to take a look at your portfolio’s asset allocation, see whether there are any adjustments that are in order. The question for you, Colleen, is how often should I be doing that sort of portfolio review to assess whether it’s time to rebalance?

Jaconetti: We generally say to look at it semiannually or annually–on an anniversary. We really try hard not to tie it to a market event. So, maybe once a year in October or November, before the holidays get crazy, look at the portfolio and just see whether your current asset allocation is more than five percentage points away from your target. If your current asset allocation is 65/35, but your target was, say, 55/45, then you should definitely be considering rebalancing back to the target allocation.

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Benz: And I know that you, in the past, have worked on looking at what is the optimal time to rebalance. What is a divergence that’s too small to bother with–that 10-percentage-point gap obviously needs to be address–but what’s kind of the optimal allocation change to trigger rebalancing?

Jaconetti: It really comes down to a trade-off. How closely does someone want to stay close to the target allocation and what costs are they willing to incur to stay that close? We looked at different frequencies. So, if you rebalance every day, every month, every year–and we came [to the conclusion that] semiannual or annual will be frequently enough, and then only rebalance if it’s more than 5% out of whack.

So, if you look at, say, 1% increments–which we did–all the way up to 10%, 1% increments kept you very close, but there are a lot more rebalancing events. You may be incurring costs that you didn’t really need to, whereas 10% increments–waiting until it was 10% out of whack–it was a little bit further along. So, you were taking on much more risk, maybe, than you may have wanted to. So, we decided a good balance with semiannually or annually, look at the portfolio and only rebalance if it’s more than 5% away from the target.

Benz: You’ve alluded to the costs that can be associated with rebalancing. So, if I am rebalancing and I’m out of whack with my targets–maybe my equity allocation is too heavy–how should I go about engineering or getting my allocations back into line with also trying to reduce those tax and transaction costs? What accounts should I be focusing on?

Jaconetti: I guess the goal would be to try to minimize taxes. So, if you have a nice balance between taxable and tax-advantaged accounts, really sell down the assets in the taxable account that are either at a loss or no gain and then try to rebalance in the tax-deferred accounts or tax-free accounts. There are wash-sale rules that we need to be careful of, but you’re really trying to minimize the amount of taxes that you would incur.

You should also think about improving asset location as a part of this process. We would say that asset location is just buying assets in the right place to minimize taxes. So, in your taxable account, consider buying tax-efficient assets–index equity funds, or ETFs. In your tax-advantaged accounts, so a Traditional IRA or a Roth IRA, purchase tax-inefficient assets–taxable bonds, active equity.

So, if for some reason for the last few years, you had active equities in your taxable account, or you had taxable bonds in your taxable account and you’re in a high tax bracket, this might be a good opportunity as a part of rebalancing to improve asset location by moving them inside.

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Benz: And the other thing I think people sometimes get stuck on is that they say, “Well, I need to rebalance; I need to, say, reduce my equity allocation. Does that mean I need to give all of my equity holdings a haircut or should I try to be a little bit surgical about where I’m pulling from in order to restore that balance?”

Jaconetti: I guess surgical, in some ways. I guess I would say that we’re trying to restore the balance at the highest level; but if you see your growth is significantly overweight in value or large, or is significantly overweigh in mid/small, you could certainly look at that. I guess the most important thing would be to try to minimize taxes. And then if you need to do additional rebalancing, do it in your tax-advantaged accounts so that you’re really not incurring significant taxes in your taxable account to get your asset allocation back.

Benz: So, a lot of moving parts here.

Jaconetti: Definitely.

Benz: I want to move on to the next one, though, because it is so important with retired investors who are age 70 1/2 and are required to take those minimum distributions from their Traditional IRAs and 401(k)s. Let’s talk about what they should have on their minds as they are thinking about maybe queuing up that money to fulfill their RMD requirements.

Jaconetti: So, the first thing is don’t forget to take them. Obviously, if you don’t take your distribution, there is a 50% penalty on the amount of the distribution. So, the most important thing is to take them.

Benz: And that has to happen by the end of the year, correct?

Jaconetti: Yes. And then after that, I would say try to do it in a way that rebalances the portfolio. So, if you are overweight in stocks or bonds and they happen to be in your tax-deferred account, try to take your required minimum distribution from those monies, and you’ll actually get back into your target asset allocation without incurring any taxes at all.

The other thing is that you don’t have to spend your whole RMD. I know a lot of people get worried; they say, “I have to take more in my RMD than I really even need to spend.” And what we would say is to take the entire RMD and then reinvest the portion you don’t need to spend in your taxable account. Again, tax-efficiently, say, an index equity fund or ETF would probably be ideal for that.

Benz: Colleen, thank you so much. It’s really valuable to hear these tips as the year winds down. We appreciate you being here.

Jaconetti: Thank you. I appreciate you having me.