Tax-Savvy Investing – A Fresh Start in 2011


By Scott Allex

The New Year brings the promise of resolutions and a fresh start. Investors looking to brush away the rollercoaster market of 2010 for a more promising 2011, may consider becoming more tax-conscious in order to maximize gains.

Taxes can take a good chunk out of an investor’s earnings. Who wants to put money toward an investment that would require giving a good portion of it back to the government? Despite the current political debate over extending the Bush-era tax cuts for another two years, investors can act now to build their wealth next year.

Taxes can be a significant factor in generating returns. It’s important to understand the tax risks of various investment vehicles, which may have higher tax consequences than others, and the options for deferring or eliminating those risks. A financial advisor can help you take advantage of the following tax-efficient investment strategies to help you retain more of your potential investment earnings:

Tax-efficient asset allocation. Asset allocation is an important investment strategy for protecting your portfolio. Having a mix of stocks, bonds and cash is important but also consider having some tax efficient accounts such as a 401(k) or IRA, which allow tax deferral until age 65. Investments that generate high levels of income will come with the highest taxes. Consider placing these investments into a tax-deferred account and save on paying taxes right away. A word to the wise, don’t let tax-saving go to your head. If you have risky assets, sell them. Don’t lose everything trying to avoid taxes with unsuitable assets.

Assume your tax position. If you’ve recently received a raise, had a spouse return to work or a large source of income come your way, you will likely move to a higher tax bracket. Don’t immediately sell your assets to qualify for a lower tax bracket, instead, maintain your position for the long run; it’s more worthwhile financially. Instead, consider investing in a Roth IRA, where taxes are paid on the contribution the year you convert. In addition, consider funding your Roth to the fullest to gain the most tax

benefits. You will earn that growth after paying taxes up front. [1]

Defer taxes to put your income to work. Consider deferring taxes in the case of moving down a tax bracket after, for example, a job loss. Financial advisors suggest contributing more income to a 401(k), an IRA or 403(b) plan. Postpone taxes while putting as much of your income to work to work as possible.

Tax-efficient mutual funds. When purchasing mutual funds, consider the turnover ratio, which could determine how tax efficient, or inefficient, a mutual fund can be. A mutual fund that turns over its holdings 100 percent to 120 percent each year is probably going to generate some taxes. Investors may consider investing in index funds that turn over their portfolios 20 percent or less.

Diversify, diversify. Diversification is a wise investment strategy to minimize risk no matter what your investment goal. Try diversifying your portfolio with assets that offer different tax implications. If you find the need to cash out for any reason, do so with a liquid account, such as a savings or money market account, with taxes paid up front. This way you’re not obligated to pay taxes on the money being withdrawn. Furthermore, consider purchasing federal bonds that come free of federal income taxes. Just be careful to watch their prices, which tend to fall when interest rates rise. Note that municipal bonds may be subject to the alternative minimum tax.

To determine if you are better off investing in a tax-exempt or taxable asset, calculate what your yield on a taxable investment would be on an after-tax basis and compare that with the return on a tax-exempt investment. The calculation includes subtracting your marginal tax rate from 100 percent and multiplying this percentage by the rate of return that the taxable investment is earning. This will produce your after-tax yield.[2]

Charitable contributions help offset gains. Balance any capital gain by donating to charity. Federal law attaches the value of itemized deductions to your tax bracket. For example, a person in the 35 percent tax bracket could reduce their tax liability by $350 by making a $1,000 gift, according to an article in On Investing magazine (Winter 2010).

I am available to speak with you about tax-efficient investing to help lessen your tax obligations and potentially increase your returns in the New Year.

S. Scott Allex, CWS® is a Certified Wealth Strategist® with and offers securities and investment advisory services through First Allied Securities, Inc., Member FINRA/SIPC. He is employed with Long Chilton, LLP and can be reached at (956) 423-3765 or via email at