Sell Now to Avoid Higher Tax Rates?

December 11, 2012

Some subscribers have wondered if they should sell fund shares to realize gains before the end of the year because taxes may be higher in 2013. We believe there is little or no advantage to making portfolio changes based on predictions about where taxes will be next year. Instead, it’s more important to follow the Upgrading strategy and make portfolio changes based on how a fund is performing against other funds with similar risk.

We also know that as Upgraders, we don’t have as many large embedded gains in our portfolios as investors who follow more passive strategies. Because Upgrading is an active approach, we tend to realize gains as we go. When we sell a fund to buy a better performer, we realize a gain (or, at times, a loss). Because of this, we often don’t end the fiscal year with a lot of unrealized gains. In our model equity portfolio, the Monthly Upgrader Portfolio, for example, we have realized more gains so far in 2012 than the amount of unrealized gains on our current holdings.

If, however, you have a buy-and-hold position that you’ve held for a while outside of your Upgrading portfolio in a taxable account, and you intend to sell it soon, it may be to your advantage to do so before the end of 2012. Long-term gains on stocks and mutual funds (held longer than one year) are currently taxed at 15%, if you are in the 25% tax bracket or higher. If you’re in the 10% or 15% percent bracket, as are many retirees, your rate this year on long-term capital gains is zero. Come January, that rate may rise to 20% or more, even for taxpayers in the lower tax brackets. Before you sell a mutual fund, you should know where you are going to reinvest the proceeds.

As always this time of year, be aware of any taxable distributions a fund is scheduled to make in December. Don’t step into an unnecessary tax liability. If you can, schedule your purchases so they occur just after any large distribution is made. Keep in mind that if your investments are in an IRA or other tax-deferred account, you will not be affected by any changes in tax rates.

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