2020 is the year that you never anticipated happening. A worldwide pandemic pretty much upended your life, and the stock market got turned upside down as well.
While you can’t produce a magical cure that will end the pandemic and restore your life back to normal, you can get your investment accounts back on track. These four moves will help.
1. Rebalance
Because of market volatility, the asset allocation model you started the year off with might look different than the one you have now. Despite a huge decline in the early part of 2020, stocks have rebounded and year to date, the S&P is up 15%. Because of this, if you own stocks, your allocation might have become more aggressive. Unchecked, this could cause bigger losses than you expect if the market corrects again in the near future.
You can fix this problem by rebalancing or selling the asset classes that have done the best and buying the ones that have performed the worst. Wrapping your head around getting rid of winners and buying losers is incredibly hard, but it is the premise behind buying low and selling high — thus necessary.
Rebalancing helps you get back to the right mix of stocks and bonds but also sets you up for success in the future. Why? Because it’s common that the asset classes that performed the worst in a prior year end up doing a lot better in subsequent years.
For example, in 2007, before the financial market crash, emerging markets were the best-performing asset class and REITs were the worst-performing class. In 2008, emerging markets became the worst and REITs ranked No. 3. If you rebalanced at the end of 2007, you would’ve benefited from this trend.
2. Tax-loss harvest
When your investments do well and you sell them out of your taxable accounts, you will owe taxes on your gains. You can offset the amount of taxes that you owe by tax-loss harvesting. In order to do this, you will also have to sell some securities that are trading at a loss.
But how do you accomplish this if you’re supposed to be selling your investments that have done well when you rebalance? Think about any duds that you have that you’ve been wanting to get rid of but you’ve held on to for emotional reasons. Ask yourself the question, if you had the chance to buy it today, would you? If the answer is no, consider selling it, taking your loss, and getting some benefit from it for tax purposes.
You can use capital losses to offset any capital gains you have. You can also use up to $3,000 in capital losses in additional capital loss to offset other types of income, such as interest, dividends, or wages and salaries. Any additional capital losses you’re not allowed to use in one year can be carried forward to use in future years.
3. Max out your 401(k)
If your employer offers a tax-deferred investment account like a 401(k), you have a big tax advantage that you can use. In 2020, you can contribute up to $19,500 to a defined contribution plan, and if you’re over the age of 50, you can add another $6,500. The amount that you contribute gets deducted from your taxable income for the year.
This means that if you make $100,000 and you contribute the maximum amount, your taxable income gets reduced to $80,500 — $74,000 if you’re older than 50. For an IRA, you can contribute up until the tax deadline in the following year, but for your 401(k) or similar qualified plans, you only have until year-end.
4. Open education accounts for your kids
There are a number of investment vehicles that you can use to save money for your child’s education, but the 529 plan offers many tax benefits. These types of accounts don’t offer a federal tax deduction, but you may qualify for a state tax deduction depending on the state that you live in.
With a 529 plan, your investments will also grow tax-deferred and as long as you use the money for qualified education expenses the distributions will not get taxed. Contribution limits are often extremely high, although if you put more than the annual gift-tax exclusion of $15,000 in 2020 into a 529, you’ll need to look at potential gift tax consequences. You must open your accounts for your children and add money to them before the end of the year, though, if your state offers a deduction that you plan to use.
Investing for success involves more than just picking the right investments. Truly maximizing your returns means that you’re using all of the tax advantages and investment strategies that you can. Taking these investment actions at the end of each and every year will help you make the most of the current year and get the planning process started for the next year.
