After income taxes are filed, it's always a good time to review investments to determine if it's a portfolio rebalance is needed. And if gains were low, whether there is a need to add income producing investments, or if too many gains whether to sell some.
Large amounts of dividends or interest from an investment can still be made, but placing them in a tax-deferred account can prevent paying taxes now. On the other hand, paying taxes now on these investments may make sense, especially if the gains can be paid at lower tax rates, such as the 15 percent long-term capital gains rate (scheduled to rise to 20 percent next year). Moving around where certain investments are held -- taxable or tax-deferred -- can help manage taxes.
While this rebalancing is being evaluated, also make sure the overall allocation to each type of investment has not been thrown out of line with market gains and losses. If large caps have grown too large and bonds too low, shifting assets can keep a portfolio from being lopsided.
Investments should also be evaluated for how well they are performing according to the index they follow. For example, a large-cap fund can be compared to the Standard & Poor's 500 index. This is even true for index funds. If a small-cap index fund doesn't track the returns of a small-cap index, something could not be right.
One thing that may not be right is the fee the fund charges. A fund that charges 1 percent expense ratio will likely return 1 percent less than the index it follows. Therefore, it's important to evaluate the fees the fund charges and determine if it's time to move to a lower-cost fund.
ADVERTISEMENT
Discount broker Charles Schwab understands the importance of low costs by offering exchange-traded funds that charge as low as 0.08 percent. Investors have paid attention. The assets of its eight ETFs passed $1 billion five months after being offered. What has helped is Schwab clients are able to buy and sell the ETFs without paying a trading commission.
A recent study done by MarketRiders gave a look at how high fees hurt over long time periods. It makes investors turn their head and consider lower costing ETFs instead of mutual funds.
MarketRiders created two portfolios. Each started with $100,000 and assumed a $4,000 annual contribution, an average expense ratio of 0.21 percent for the ETF portfolio and a 1.39 percent for the mutual fund portfolio and an annual return of 7.5 percent.
An investor who opened each account at age 35 would have seen the mutual fund portfolio grow to $2.04 million by age 76 while the ETF portfolio grow to $3.15 million. The example shows the power of compounding over a long time period even with such a small expense difference.
Managing a portfolio is not investing in what's hot or what is returning more, but a careful consideration of many factors that affect taxes and growth.
