We subscribe to a number of resources here at Cascade Investment Group. Recently, I saw this article on tax and investment decisions published by RBC Capital Markets and thought I would pass it along. Taxes are an important factor to consider as we work with you to accumulate, preserve and pass along wealth. We believe a strong tax plan, worked out with your tax professional and reviewed and understood by us, can accelerate the process of growing your asset and income base over time.
We work you on a regular basis to help understand risks inherent in investing, in any particular security and how those investments can help you in the long run. Call us after this tax season for a portfolio review while your tax picture is fresh in mind so we can plan for the rest of 2013.
Don’t Let Taxes Drive All Investment Decisions
The recent debate about investment-related taxes — specifically, those taxes on dividends and long-term capital gains — reflects a continuing argument in this country over whether income from investments should be taxed at about the same rate as income from employment. But this discussion tends to obscure a rather important point, which is that taxes typically should not be the key driver of investment decisions.
Of course, everyone’s situation is different. If you are a retiree, and your cash flow depends a great deal on dividend payments, then the tax rate on dividends could matter quite a bit to you. Consequently, you may be glad to know that the new tax laws leave the 15% dividend tax rate unchanged for most people. (The rate rises to 20% for singles earning more than $400,000 per year, or for married couples earning more than $450,000 per year.) But if you’re still in your working years, and you’re evaluating investments, you should probably look at a variety of other factors more closely than taxes.
So, ask yourself these questions about any investment you’re considering:
Will It Help Me Diversify My Portfolio? If you owned only one type of asset, such as growth stocks, and they underperformed for a while, your overall portfolio would obviously take a hit, perhaps a sizable one. But if you spread your investment dollars among a range of different vehicles — growth stocks, international stocks, bonds, government securities, real estate and so on — you’ll lessen your exposure to a sudden and sharp downturn that primarily affects one type of asset, and you’ll give yourself more chances for success. So, before adding any new investment, consider its ability to help diversify your portfolio. If you already own several other investments that are substantially similar to the one you’re considering, you may need to look elsewhere for diversification opportunities.
What Risks Are Involved? Every investment carries some type of risk. When you own stocks, you must deal with investment risk — the risk that your investment will lose principal. If you invest in bonds, you incur interest-rate risk — the risk that, as interest rates rise, the value of your bonds will fall. You also face inflation risk — the possibility that your investment may not even keep up with inflation, thereby depriving you of purchasing power over time. So, when evaluating a new investment, you must consider what type of risk it brings to your portfolio and whether that risk is acceptable, given your individual risk tolerance.
Does This Investment Offer Reasonable Growth Potential? When you’re accumulating resources for retirement, you’ll need a reasonably large percentage of your portfolio devoted to growth-oriented investments, such as stocks. It’s true that the value of these investments will fluctuate, but for much of your working life, you’ll have enough time left to overcome any dips you might experience. When you retire, you may need to readjust your portfolio so that it provides more income-producing opportunities, but, even in retirement, you’ll still need some growth potential to keep you ahead of inflation.
What is its “Track Record”? If you’ve been investing for any time, you’ve no doubt seen this disclaimer: “Past performance does not guarantee future results.” And this statement is absolutely true, because there are very few guarantees in the investment world. Nonetheless, if you’re considering an investment such as a stock, or a stock-based mutual fund, it’s far from pointless to look at that investment’s history. By studying an investment’s track record, you can see how it has performed in a variety of investment climates and economic environments. Even if this information isn’t totally predictive, it can at least give you a pretty good idea of what to expect in “up” or “down” markets.
Would I Still Want to Own This Investment in Five Years? Warren Buffet, perhaps the world’s most famous investor, has a rather simple investment philosophy: Look for good companies and hold them forever. Of course, you may only need to hold some investment vehicles, such as certificates of deposit, for a short period of time. But when you’re investing in equities, you may well want to follow Mr. Buffet’s example by purchasing high-quality companies and holding them for the long term.
Do I Understand This Investment? It sounds pretty basic, but it’s nonetheless important: You need to understand every investment you own. What are the objectives of the investment — growth, income or a combination of both? What are its risk factors? How might its performance be affected by “macroeconomic” factors — inflation, rate of economic growth, etc.? If you don’t fully understand an investment, you run the risk of encountering unpleasant surprises down the road.
Taxes will always be part of the investment equation. But for most investors, most of the time, taxes should not be the key factor in making investment choices. Instead, consider the questions listed above — the answers will go a long way toward helping you make the right decisions.
For more information on how the new tax laws on dividends and capital gains may affect individual investments, please call.
Rob Wrubel CFP®, AIF®,is a Senior Vice President, Investments with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.