In a time when the whole world seems turned upside down by the Coronavirus pandemic, you’d think Uncle Sam’s tax collectors could give us all a break, right? Sadly, however, the IRS doesn’t see it that way. It was welcome news, back in March in the confusing and scary early days, when Washington announced that we didn’t have to file our returns until July 15, but “later” isn’t the same as “never,” is it?
As a thriving retiree, you still need our investments to keep working for you, and since taxes are going to keep coming due even amid the COVID-19 pandemic, it’s important to remember some key things that you can actually control. After all, none of us can control the virus that’s causing all the trouble, we aren’t in charge of what the IRS does, and we can’t control (or predict) how the financial markets will react to any particular 24-hour news cycle. But you can take some smart steps with your investments that will help you feel more in control of your future financial wellbeing, and you can also take advantage of some opportunities that our current, unpredictable environment presents to lower your tax bills in the future.
First, let’s look at some basic principles of portfolio design that put you in the driver’s seat. Practicing these fundamentals will go a long way toward giving you greater peace of mind and less distraction from the background noise created by the financial news media.
As I always tell my clients at every opportunity, “Stay diversified, stay your course.” When I build a diversified portfolio for my thriving retirees, I want to make sure that they have different types of assets included: a diverse mix of equity (stock) and fixed-income (bond) investments that balances risk across multiple categories and reflects my client’s stage of life and ability to tolerate risk. For thriving retirees, we tip the balance more toward safety (fixed income) while still including enough equity holdings to provide growth potential for funding a long, healthy life in retirement.
The basic principle of diversification is that by holding a wide array of different asset types, we modify the overall volatility of the portfolio. In times like these, that’s a huge benefit. While we can never completely remove all volatility, diversification is the power tool for building security during unpredictable markets.
2. Asset allocation
When I said earlier that we “tip the balance” in a portfolio, I was talking about asset allocation, the process of adjusting the mix of investments to reflect a client’s risk tolerance and stage of life. For thriving retirees, I allocate more of the portfolio to less risky investments, such as high-quality corporate or government-backed bonds. But even here, we typically want to include some equity holdings to allow sufficient growth for future needs. I work carefully with clients to calibrate the right allocation mix for their unique situation.
In any given period of time, it’s inevitable that some assets in a portfolio will grow, and others may lose value. This means that in order to maintain the proper asset allocation, you’ll need to sell some assets and buy others. I help my clients rebalance in a disciplined way to keep their portfolio in line with the long-range strategy we’ve set up.
4. Tax-loss harvesting
Finally, let’s talk about how we can turn losses into future wins. When we rebalance, as mentioned above, we typically have to sell some of the investments in a portfolio and buy others. Often, we need to rebalance because one part of the portfolio has increased in value to the point that the asset allocation is out of balance. But guess what happens when you sell an investment that has made money? You pay taxes on it (remember, the tax collectors never take a holiday). This is where tax-loss harvesting can really help.
When the stock market dropped because of the Coronavirus, most portfolios showed losses — on paper. What tax-loss harvesting does is sell an asset that has dropped in value, transforming a paper loss into a real loss. Why would anybody want to do that? Because we can essentially put that realized loss in a box and save it for later. In a year or two, when the market resumes its upward trajectory — which it will, if history is any indication — you’ll probably need to rebalance, which will mean selling an asset for a profit. But instead of paying taxes on that profit, I can go to your box and take out that loss we realized during a down market and use it to offset the gain on your sale. Voilà! Your portfolio is rebalanced, and you didn’t have to pay taxes on your gains. You’re welcome!
Especially in extremely uncertain times like those we’re living through now, it’s vital to remember what you can control and what you can’t. When the headlines are screaming about the latest outbreak or the latest drop in the Dow, you can rest easier, knowing that your portfolio is designed to weather volatility because of diversification. You can remember that your asset allocation is adjusted for your personal risk tolerance and stage of life. You can look forward to opportunities for rebalancing, and by taking advantage of tax-loss harvesting, you can minimize the toll that that IRS takes on your investments — conserving more for you to fund the thriving retirement lifestyle that you need.
If you have questions about tax-loss harvesting or any other investment matter, I’m here to help. If you’d like to read a recent blog article with more information on tax-loss harvesting, click here.
Stay Safe, Stay Home, Stay Hopeful!