Archive for the ‘Investment Planning’ Category

The volatile markets have created tax-planning opportunities that you should consider as the year winds down.

Capital Gains/Losses

Your capital losses from the sale of investments will offset your capital gains. If your losses exceed your gains, the IRS allows you to deduct an additional $3,000 against other income and any unused losses may be carried forward to use in future years. For example, if you have losses from the sale of investments, consider selling (if selling makes sense within the context of your goals) investments with gains prior to year-end. The gains will be offset to the extent of your losses.

If you want to recognize both gains and losses in two different stocks, or mutual funds, the sale of each will allow you to offset the gains with the losses. If you really like the stock, or mutual fund, that you sold at a loss, you can repurchase a similar stock, or fund. To avoid the “wash sale” rules you must purchase a similar investment but not an identical one or the loss will be disallowed. When implementing such a strategy, you should also consider any associated transaction costs.

Mutual Funds

With regard to mutual funds, here are a few items that you should keep in mind. Funds usually distribute capital gains every year. The deemed distributions are taxable to the shareholders even though no cash has been received. Call your funds and ask about capital gain distributions for 2002. With this information, you can plan to implement some strategies prior to year-end. Also, if you are planning on selling or buying shares of funds, you need to know the dividend dates. If you are buying, you should purchase shares subsequent to the date. And if you are selling, you should sell prior to the date. With regard to a sale of shares, you also need to consider the different methods available in determining your basis. There are several methods and the method you elect can have a significant impact on the amount of gain or loss you need to report to the IRS.

Charitable Donations

Consider donating appreciated stock or mutual fund shares to a qualified charitable organization instead of cash. If done properly, you do not report any gain on the donation and you receive a charitable deduction equal to the fair market value of the investment. If you are considering donating an investment that has declined in value, sell it first, and donate the net proceeds, that way you will be able to deduct all or part of the loss in the year of the sale and receive a charitable deduction for the cash contributed.

Corporate MMAs are very similar to traditional MMAs in operation, but offer a higher yield. They are also less secure than traditional MMAs that are insured by the FDIC, because your investment is only backed by the corporation’s promise of repayment, and in the case of bankruptcy, you become essentially an unsecured creditor.

In a traditional MMA, the institution invests your money in low risk (US Govt. & Agencies, CDs, Commercial Paper) investments. Corporate MMAs invest in higher yielding investments, such as equipment leases and consumer loans.

Currently, GM is offering a yield of 2.75% for an investment of $50,000 or more. The average current yield for traditional MMAs is around 0.60%. Ford, GE, and Caterpillar are also offering corporate MMAs.

If you think that these accounts may fit into your overall investment strategy, approach it as if you were investing in bonds of the corporation, and base your decision not only on the current yield of the account but also the credit worthiness of the corporation.

This vehicle protects against the devastating impact of inflation on fixed income investments.

I Savings Bonds are accrual securities, which means interest income payments are not received until the bonds are redeemed or mature (up to 30 years). Federal income tax on the interest can be deferred until redemption or maturity. Also, the interest is exempt from state income tax.

The interest rate is a combination of two separate rates: a fixed rate of return, and a variable semi-annual inflation rate based on the CPI-U. In the unlikely event of deflation, the value of the bond remains at its pre-deflation level. Moreover, because they do not trade in the secondary market, their value never decreases.

As a result of being structured as long-term investments, there is a three-month interest penalty if redeemed within five years of purchase.

I Savings Bonds are very attractive for retirement savings outside tax-deferred accounts, and, as an added bonus, they qualify for the education tax exclusion.

TIPS are a special type of Treasury note and bond. Interest is paid every six months and the payment of principal occurs at maturity as with most other types of notes and bonds. But, with TIPS, interest and redemption payments are adjusted for inflation as measured by the CPI-U. At maturity, the TIPS note/bond is redeemed at its inflation-adjusted principal amount or its original par value, whichever is greater. Also, as with most other notes/bonds, TIPS pay a fixed rate of interest. However, the fixed rate is applied to the inflation-adjusted principal, and not the par amount of the security. As a result, if inflation occurs throughout the life of the security, each interest payment will be greater than the previous one.

TIPS are exempt from state income tax and subject to federal income tax. In any year when the principal grows, the increase is taxable in that year, even though you will not receive the inflation-adjusted principal until the security matures. Because of this, TIPS should be held in a tax-deferred account, rather than in a taxable account.

Many investors in recent years have put money into bonds or bond mutual funds in order to receive interest income and to assure that their investment will not decline in value.

Be aware that you can lose principal in a bond investment. A decline in value primarily depends on interest rate fluctuations.

All bonds are affected by interest rate risk, regardless of the issuer’s credit rating or whether the bond is “insured” or “guaranteed.” For example, you purchased a 30-year bond when 30 year Treasuries were yielding 4%. Now you want to sell the bond and interest rates for the same maturity are currently 10%. Why would someone purchase your bond, with a coupon rate of 4%, when they can buy a new issue paying 10%? If you really need to sell it, the only thing you can do is mark down your bond. You would have to mark down the price to where it would yield 10%. That would be about 30 cents on the dollar, or about $300 per bond. As a result, you would have to sell your $1,000 bond for $300, resulting in a $700 loss.

Interest rate risk impacts long-term bonds more than short-term bonds. The best protection is to own short (under one year) or intermediate (between one and ten years)
maturities.