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Tuesday, September 24, 2013 | Issue #2128
Earn Thousands More on Your Portfolio, Risk-Free
Alexander Green, Chief Investment Strategist, The Oxford Club
|  Last week I participated in a special Oxford Club conference on tax minimization for investors held - appropriately - in Washington, D.C., the home of runaway spending and the incumbents responsible who want you to pay for it.
In my experience, most investors fail to understand how unnecessarily forfeiting thousands of dollars in investment taxes is costing them the long-term financial security they desire. Others realize the hurdle that high investment taxes pose, but shrug their shoulders and figure there isn't much they can do about it.
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This is blinkered thinking. By following the few steps I'm about to outline here, you can save yourself many tens of thousands of dollars in taxes in the years ahead.
Three Simple Steps
Step one is a no-brainer. Triple-A municipal bonds now yield about the same as Treasurys with equivalent maturities. The big difference, of course, is the munis are exempt from federal taxes. If possible, buy your own state's bonds to avoid both federal and state taxes.
Second, do your short-term trading in your retirement account. Why? Because short-term gains are taxed at the same level as your top marginal income tax bracket, which may be as high as 39.6%. That's essentially twice as high as the maximum long-term capital gains tax rate of 20%.
Step three is your "asset location" strategy. No, not asset allocation. That refers to how you divide your portfolio up among stocks, bonds, cash, etc. Your asset location strategy refers to putting your least tax-efficient investments in your qualified retirement plan so they compound tax-deferred.
For example, Treasury bonds, corporate bonds, real estate investment trusts and TIPS all make annual distributions that are fully taxable at your top marginal rate. So hold these - or the equivalent funds or ETFs - in your IRA, SEP, pension or 401(k). That way there's nothing for the IRS to take each year.
Individual stocks and equity index funds, on the other hand, are highly tax-efficient. Hold these in your non-retirement accounts. Let me explain why.
Unlike actively managed equity funds - virtually all of which underperform their benchmarks over periods of 10 years or more - index funds rarely make capital gains distributions. So if you don't sell, you generally won't have a tax liability.
The same is even truer with individual stocks. As Warren Buffett points out, "the capital gains tax is not a tax on capital gains. It's a tax on transactions." In your taxable accounts, reduce your turnover and, whenever possible, hold investments for more than 12 months to qualify for the 20% long-term capital gains tax rate.
Win by Losing
And even if you do lock in gains in your taxable account, you still have the opportunity to offset them with realized losses. At the end of each year, you should harvest your losses to reduce your tax bill. (And, from a performance standpoint, it's not a bad idea to sell your laggards from time to time.)
Be sure not to buy these stocks back for at least 30 days. Otherwise you will run afoul of the "Wash-Sale Rule," and the IRS will disallow the tax loss.
There is nothing shady or even the least bit questionable about following these basic, common-sense strategies to reduce the annual tax burden on your investment portfolio. As investment legend John Templeton used to note, there is only one way to measure long-term investment success: maximum total return after expenses and taxes.
Using these simple techniques will add many thousands of dollars to the net value of your portfolio in the years ahead.
Good investing,
Alex
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