• Tax Strategies
  • U.S. Fiscal Uncertainty and Your Portfolio

    by Charles Rotblut, CFA

    The fiscal cliff loomed as we sent this issue to the printer three weeks before the November election. Unless Congress and the president reach an agreement, tax cuts enacted under the George W. Bush administration will expire and automatic budget cuts will go into effect on January 1, 2013. As I said in my Editor’s Note, we are delaying publication of our 2012 tax guide until the January 2013 issue in hopes that we will have more clarity about 2013 tax rates.

    Congress is expected to reconvene on November 13. It is possible that both parties will agree on a plan or at least be close to agreeing on a plan by the time you read this. It is also possible that no agreement will have been reached and fiscal uncertainty will still loom. Either way, there are portfolio actions you can and should not take heading into the new year.

    Use the tax status of your accounts to your advantage

    If you have an individual retirement account IRA or a Roth IRA, use them for your less tax-efficient investments and strategies. Capital gains, dividends and corporate bond interest payments are not taxable events when they occur in an IRA or a Roth IRA. (You will pay taxes on amounts withdrawn from a traditional IRA, however.)

    Use your taxable brokerage accounts for your most tax-efficient investments, such as index funds and municipal bonds.

    Consider the tax advantages of municipal bonds

    Not only is interest earned from municipal bonds generally exempt from federal taxes, it may also be exempt from state and local taxes. (Check the tax laws for where you live.) Plus, interest earned from municipal bonds is excluded from the new Medicare tax scheduled to go into effect next year.

    Fears about widespread municipal bond defaults are overblown but, like any asset, you should analyze the risk characteristics of the specific bond you are considering.

    Don’t fear dividend stocks

    If no resolution is reached, tax rates on qualified dividends will rise to ordinary income levels. If this does occur, there are reasons to believe dividend stocks should not specifically be adversely affected. First, more than 80% of the S&P 500 companies now pay a dividend, so any aversion to dividend stocks will impact the entire market. Second, many dividend stock investors are either institutional investors (pension funds, endowments, etc.) or individual investors holding these stocks in an IRA. Neither group will be impacted by the higher tax rates. Third, analyses of the 2003 tax cuts suggest a weak link, if any, between tax rates and the performance of dividend-paying stocks. Finally, if the fiscal cliff occurs, the impact will reach far beyond dividend stocks.

    Estimate your 2012 tax bill

    Tax rates, with the exception of the alternative minimum tax (legislation for a patch to the 2012 AMT has yet to be passed by Congress), for this calendar year are known. Use the known rates to estimate how much you will owe. Then, look at forthcoming taxable events. While we do not advocate letting taxes determine your investment decisions, if there are profits or losses you intend to realize this year or next, regardless of what Congress does, you may want to take the timing into account. Depending on your tax situation, it may make more sense to realize those events this year or delay them until next year. A tax professional may be able to help with this decision.

    Diversify your investments

    Any deficit reduction plan will make cuts to government spending and adjustments to tax rates. Rather than trying to guess who winners and losers will be, hold a variety of investments, including stocks from a mixture of industries and sectors.

    Contact your representative and senators

    Their job is to represent your interests, so don’t hesitate to speak up.

    Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


    Fred from PA posted over 4 years ago:

    It is a disgrace that our elected officials put more time and energy into keeping their jobs and getting reelected than it making common sense corrections to our tax codes.

    Investors at all levels are insecure about their unknown future.

    We have worked and saved all of our lives and now that retirement is close at hand, government inaction will diminish our efforts.

    Leroy Siewert from CO posted over 4 years ago:


    Joseph Turney from KS posted over 4 years ago:

    I discovered that tax exempt Income is included when Social Security figures your gross income. I would like to know where this authority came from.

    Max Higgason from IA posted over 4 years ago:

    When a political office became a profession We all lost out!

    Ashok Choksi from CA posted over 4 years ago:

    You have not commented on the direction of stock prices, based on your best guess about the outcome of Fiscal Cliff. For instance I have about $25,000/- to invest. Should I wait for the outcome or should I go ahead and invest now? It is not important that your guess should prove correct. Any informed guess is better than drifting.

    Ashok Choksi

    Charles Rotblut from IL posted over 4 years ago:

    We do not recommend attorneys or advisers. You may want to check with bar association for the state you live in or are moving to.

    Last year, we published an article with questions to ask a financial professional (including lawyers) you are considering hiring. You find it at:


    H Mc allister from AR posted over 4 years ago:

    I think the only solution to our self indulgent congress is "Term Limits"

    Alfred Falcone from NY posted over 4 years ago:

    what are your thoughts about inflation, rising interest rates and their role in the deficit?

    Alfred Falcone from NY posted over 4 years ago:

    what are your thoughts about inflation, rising interest rates and their role in the deficit?

    Arthur Gilbert from NC posted over 4 years ago:

    The federal budget has increased 7+% per year for 4 years. The sequester would barely dent one year's escalation and provide a ray of hope that would be stimulating to the economy in my opinion. Any simple agreement on taxes would put the issue to bed near term. I would pay more in tax if it was earmarked for debt reduction instead of spending increase.

    Ralph Hellender from FL posted over 4 years ago:


    Sime Sunjara from CA posted over 4 years ago:

    I just signed up. I've been investing/trading for over 10 years and I am yet to find a newsletter to be happy with. What I am looking for is buy/seel recommandation where I will not lose more than 20% on that recommandation, specially when there is already a gain of 20% or more on the same position. As a new subscriber I can not buy whole Portfolio I would like to see some of the best present recommandations to start investing with you. I do not beleave in in long term investing.

    Thank you,

    SAM CA

    Charles Rotblut from IL posted over 4 years ago:

    Hi Sam,

    Trading too frequently can harm your long-term performance. I would suggest reading this article by Mark Hulbert, which looks at the impact transactions have on investment newsletter performance.



    Lorene Farmer from MO posted over 4 years ago:

    I certainly agree on term limits for congress and also having a review of their benefits including their salaries and I think it is ridiculous that they make these decisions for themselves. I would like to see the number of federal employees reduced by 50% and much of what they do returned to the state and local level.

    William Crutcher from TX posted over 4 years ago:

    Our elected Washington folks have no skin in the game...

    Their "retirement" income is assured
    They have a separate health care plan
    Most are already wealthy
    All they worry about is being re-elected

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