Tax Reduction Strategies To Help Your Portfolio During A Crisis

Portfolio Decisions: A Tale of Two Investors

How much of a difference can these tactics make when it comes to minimizing taxes and protecting your portfolio? To answer that question, let’s compare two investors: one who plans their investments around tax implications and one who doesn’t.

John’s Investment Strategy

John has good intentions to manage his money, but his career and family often take up most of his time. Although he invested some money several years ago — adhering to a 70/30 allocation for stocks and bonds — he hasn’t done much with it since.

Now, his allocation has shifted to 85/15. As a result, his portfolio is more aggressive than he intended, making him more susceptible to losses during market declines. He’s also neglected his Roth IRA and has amassed a small balance since he has forgotten to make annual contributions.

Although John does make charitable gifts, he doesn’t contribute enough to itemize his deductions — so he receives no tax benefit. After the downturn, John could have taken advantage of tax-loss harvesting to offset future gains. However, he didn’t pay enough attention to his finances to even know this was an option.

Jenny’s Investment Strategy

In comparison, Jenny realized she didn’t have the time or desire to deal with her investments on her own. She works with a financial advisor to make portfolio management and investment decisions. She and her advisor have kept her 70/30 allocation intact through continual rebalancing over the years.

Now that the market is in a downturn, 30% of Jenny’s portfolio remains in safer assets (e.g., bonds). So, she’s less susceptible to market volatility. She also has made annual Roth contributions that have compounded over the years to a great size.

During the downturn, some of Jenny’s funds have lost value. Through tax-loss harvesting, however, she captured $50,000 of losses. She can now use that to offset gains for several years on her tax returns. Jenny also has been “clumping’ her charitable donations, which enables her to receive a tax benefit every few years. In addition, she has been contributing to a 529 plan for her kid’s education. This has earned her a tax deduction now, and the money in the account grows tax-free.

When you think about how to handle your investments during a downturn, take a page from Jenny’s book. While taxes won’t be the sole driver of your portfolio management and investment decisions, they should be an important consideration. Although you can’t control the stock market, there are plenty of proactive planning and tax reduction strategies you can take advantage of — in any market climate.

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