3 Year-End Tax Strategies (Audio Podcast)

December 7, 2019

On this episode, Karl Eggerss discusses the persistency of the stock market plus it’s that time of year to do these 3 things to help minimize taxes.

Hey, everybody. Welcome to Creating Richer Lives, the podcast. Thanks for joining me. Appreciate it. As always, just a reminder, the podcast is brought to you by Covenant, lifestyle, legacy, philanthropy. And if you need any information on the services Covenant provides, (210) 526-0057. And the website is creatingricherlives.com, a lot of information on there, especially if you’re new and you’re trying to learn some things, but also just keeping up with what’s going on, whether it’s tax changes. We talk about things that could impact you, things that are in Congress that could impact you from a tax standpoint. Whether it’s social security or Medicare, I try to have different people on the podcast to give you that information when it’s coming out.

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Another somewhat interesting week in the market. I wouldn’t say it was the most exciting week, but it was interesting to watch a market that has been, I would say, overbought, which is a technical term. But overbought the last probably two, three weeks, has stayed there, and really has not changed in terms of that condition. And yet the market refuses to go down. And it had a chance earlier this week, and it just didn’t do it.

Now before we get into that, I’m going to spend some time in just a little bit talking about some things that you should be considering or doing at the end of the year here because we are about three weeks away from the calendar flipping. And there’s some things you should be doing or at least reviewing right now before the end of the year. And so we’ll talk about a few of those things.

But as we enter the end of the year, interesting to see and compare where we were in 2018, December of 2018, to where we are now. We had a 20% drop in late, late in the year, which really ended around Christmas Eve, very different than where we are today. So I’m going to touch on that in just a minute and why I think the market does look so different a year later.

Really, this week was all about the China trade deal because came in on Monday, the Dow was down 260 points. We had some weak economic data. We had ISM Manufacturing was weaker. Gold did well. Emerging markets did well. Bond should have rallied that day. Interesting to watch because interest rates should have gone down based on weak U.S. economic data, but they didn’t. Actually went up. And of course, it was Cyber Monday. The whole brick and mortar declining while internet takes over, that continues at a pretty rapid pace. So more and more people continuing to shop, but they’re just doing it in a different way than they’ve done it in years past.

Tuesday, very interesting because Trump came out and said, “Look, we might be better off to wait on a trade deal until after the 2020 election.” Boy, it’s not what Wall Street wanted to hear. The Dow Jones was down about 450 points at one point, actually rallied throughout the day, and finished down about 250 which of course is about 1% now. Not as much as it used to be. And Wednesday, market bounced back a little bit. Thursday, Market was kind of flat. But Friday, we got this big jobs report yesterday, right? We got 266,000 jobs created in the month of November compared to what was supposed to be 180,000.

Now, as I’ve told you in the past, when the numbers are bad, the numbers are good, take it with a grain of salt because they’re always revised. We need to see trends, and that’s still the case. Interesting though that last month’s was revised up by 28,000 as well. So not only did it beat by 80, 90,000, it also was revised up. And the unemployment rate fell to about three and half percent. So that was the good news. That’s what got the market jumping up about 330 points on Friday and really salvaging the week.

But there is some economic news coming out that’s still not great, and so we still have a mixed bag here in terms of the U.S. And while there may be some green shoots overseas in various areas, still some weak data over there as well. But is it collapsing? No. And investors on Wall Street know the jobs report, it’s a heavyweight. It’s one of the most important economic releases we have because that’s the consumer, right? And people working, they’re going to spend money. They’re 70% of the economy. Enough said. So it gets a heavy weight but still a mixed bag.

But here’s the deal. This is something that is in stark contrast to where we were in December of 2018 versus where we are in December, 2019. Remember in 2018, the Fed had hiked and said they were going to raise interest rates three more times in 2019. What have they done? They have lowered interest rates three times. For you sports fans, you ever see when… And I’m a Spurs fan. So let’s say the Spurs come down. They miss a three pointer. And let’s say the dreaded Houston Rockets, I know we have a lot of Houston fans out there, let’s say the Rockets come down. Which by the way, we won, right? Spurs won earlier in the week even though there was a controversial call where Harden dunked it and the ball came back out of the net.

Anyways, so let’s say that the Spurs shot a three. They missed it, come down. Harden shoots a three and makes it. You’ll oftentimes hear the announcer say, “Boy, that was a six point turnaround.” What they mean is, should’ve been three points for the Spurs. Instead, it wasn’t. So they missed out on three points, and the other team came down and scored three. So it’s really a six point swing. That’s exactly what the Federal Reserve did. From December of 2018, the Fed was going to hike, raise interest rates three times, 0.75%, quarter point each time probably. And instead, they lowered them 0.75 three times. That is a one and a half percent swing. It’s a big deal.

Has it impacted the economy? There’s a big delay in this, right, when they do this and what’s the effect. But the perception and the change of direction and the speed at which they did it was historic, “We’re raising interest rates three times next year. Oh, no. We’re not. Not only are we not doing that, we’re going to start cutting rates.” Big change in direction, and the markets have loved it ever since. Hence, we have a stronger market this year.

So we got a very sharp sell-off because the economy was slowing last Christmas, and the Fed didn’t see it. And they were actually hiking interest rates. That combination, if you go back and listen to the podcast literally two, three years ago, I was mentioning that if the Fed ever started to raise rates at the same time that the economy started to slip, that’s the bad combination. And that’s really what we saw. The Fed finally woke up, saw that the economy was slowing, and they did something about it and started cutting rates.

Fast forward to now, market’s still celebrating because they’re still… They may not lower anymore, but they saw the error of their ways. They cut. And the economy is hanging in there. And as we’ve been saying, maybe close but no cigars in terms of recession, but we’d still have some mixed signals there. But the Fed’s saying, “We’re ready to cut if we need to, but we may not right now.” But that’s been good enough for the market to say, “Get the feds out of the way.” And you know the old mantra, don’t fight the fed. It’s exactly what that means. And it was classic this particular time.

So who knows about the trade deal, but these headlines this week about trade deal, yeah, we can wait until after the 2020 election. Apparently last week over the weekend, China may have changed their mind on something. It caused Trump to come out and say, “Fine, we’ll wait on a trade deal.” Markets didn’t like that. It’s negotiating 101 again. And then something was leaked from the Chinese that they’re working towards a trade deal. And so again, markets bounce back. You can’t trade that. It’s virtually impossible. You don’t know what’s going to happen with that.

But the bottom line is the Fed’s loose, economy’s okay, good jobs number, market’s been up. And as we enter the end of the year, and I’ll talk about this in a minute what you should be doing, but remember we have people with built-in unrealized capital gains, right? Bought something earlier, maybe last Christmas, and it’s up. And they may want to take profits and start to build some cash because they’re starting to worry about the market.

But they’re not going to do it now when they could sell it January 2nd. Market’s closed January 1st. Let’s say it opens January 2nd, and they sell it then. They have the capital gains on the books for 2020, not 2019. So that could be why we’re seeing this market that’s been very, very resilient continuing to push up. But we did see… I told you about bonds earlier and how they really should have rallied earlier in the week and they didn’t. And then here, they are selling off again on better economic news, at least with the jobs report.

All right, let’s switch gears for just a minute, and as promised, let’s talk a little bit about a year end technique called tax loss harvesting. What does that mean? It’s not running out to the vegetable garden or harvesting anything else. It’s harvesting losses, and the goal is to offset your capital gains. Now, some of you may have heard of this. Some of you may have done it. Just wanted to talk through what it is and the effective way to do it.

So inevitably in some years, especially like 2019 when the stock market has appreciated and you may have taken some gains throughout the year, you’re going to be sitting there looking at your realized gains or losses. And you should at this point, or your advisor should, and we do this customarily across the board for our taxable accounts. Remember, this does not concern your IRAs, your Roth accounts, your SEP accounts, your 401(k)s. This is simply your taxable accounts. Could be trust, could be joint accounts primarily, could be an individual account with just your name on it, a transfer on death account.

So you look at your account. You look at what has been sold throughout the year. And for grins, let’s say you’re sitting there with $10,000 of realized capital gains on the books. And if you do nothing else, you will pay taxes on that in April. You sold some things. The gains on that were $10,000. You can sit there and do nothing and pay the taxes, and maybe that’s the right thing to do given some circumstances for various reasons. But you probably have something in your portfolio that did not go up this year and is down. If you have a diversified portfolio, that could be the case. If it’s really diversified, that’s usually the case or something in there that is down.

So what you have to do is obviously you could sell that position. And let’s say that position had a $5,000 loss. You sell that position sitting in the money market, and now your $10,000 realized gain now became a $5,000 realized gain because you just took $5,000 in losses. You have to sell it. You can’t just be sitting on it. You have to physically sell it. Where some people get it wrong is they may do that, and they don’t put it into something similar.

So for example, things that are down may be the very things that are going to rally, especially come the new year. So let’s just take energy for example. It’s a great example of things that haven’t done very well in 2019 whether it’s a particular positions, could be an ETF, could be a mutual fund. So you’re sitting there with energy stocks or an ETF that is down on the year. But you think it’s going to go back up. And I would agree with you, but that’s a side note. But let’s say you think it’s going to go back up. You don’t want to lose the rubber band effect of that going back up, right?

So what you want to do is you want to sell that position and go identify something that you think is going to move similarly going forward. That could mean that you are selling two or three individual energy stocks, and then you go and buy an energy ETF. Now, there’s lots of different energy TFs. There’s lots of different energy stocks. It’s not going to move exactly, but the goal that you’re trying to do is not lose your positioning necessarily, but you’re just trying to recognize the loss.

Now, you can move on to something else if you truly felt that energy wasn’t going to bounce back, but inevitably, what we see people doing is if they do this tax loss harvesting, they sell their energy. And then they may go buy something that’s already appreciated in 2019. You may be correct in that assumption, but that’s not the goal here. The goal is not to necessarily give up on the position. The goal is just to recognize the loss to offset your gains.

Interesting because if you hold that for 30 days, you can go right back and buy that same position again. Now, if you don’t hold it for 30 days or you sell it and buy that same position back within 30 days, it’s a wash sale. That means you can’t recognize it for tax purposes as a loss immediately. So be careful when you do that. Maybe give yourself even more time than the 30 days, 33 days, 34 days. But that’s the general idea of doing this.

It doesn’t really work the other way where you have losses and you say, “I need to sell some stuff to use those losses up.” It doesn’t have any material effect if you have losses on the books for the year and you’re looking at the end of the year saying, “I would like to sell a stock, but I have to pay capital gains.” Well, that’s an opportune time to lock in some capital gains because you wanted to exit that position. You wanted to reduce your exposure to that ETF, that stock, whatever it might be. And you don’t have to pay taxes on it because you already have some losses built up from maybe earlier in the year. Remember, all this stuff flows together. Losses offset the gains. They net them out at the end of the year.

So this is the time to do that. And this is exactly why the stock market is being pretty resilient right now is because in a year like this, where you have some things that have done pretty poorly but the majority of things have done really well, many folks don’t want to sell those positions now when they could sell them in a month from now and be in a new tax year. So they’re deferring selling, so they don’t have to pay capital gains come April. So that’s why you see positions continue to run up stocks continue to run up.

Meanwhile, on the other side of the ledger, you see stocks that have underperformed continue to underperform. So sometimes, you see this interesting dynamic in January where the winners from the previous year become the losers because now people are selling. Now, they’re locking in their gains in a new tax year, and then the losers that they really wanted to buy that were being used for tax loss harvesting, they’re getting more and more pressure put on them as more and more people continue to sell those, right?

Think about it. Energy down this year, that’s going to be the thing that most people use for tax loss harvesting or energy stocks. So they’re going to continue to maybe stay down at these levels. Then come January, they go on a huge run. And we’ve seen that before, and it doesn’t necessarily last. But you see some positioning as individuals are changing their allocations simply because of tax purposes.

Now again, this doesn’t apply to IRAs, but in taxable accounts, this is something you should always do. And that doesn’t mean you’re always going to get your capital gains down to zero. You may want to reduce your positioning throughout the year and lower your exposure, and so you’re recognizing some capital gains. You can certainly do that, and you may have capital gains taxes. That’s just normal. But look for those opportunities, especially doing a tax swap where you can sell something, not really change your positioning, just you’re in a new security. But if that security runs, you still have some exposure in that area.

The other thing you can do obviously with pent-up capital gains that are unrealized, things you haven’t sold, is use them for charitable purposes. You’re going to give $10,000 check to the church. Instead, take an appreciated stock, mutual fund, give that and the value of that of $10,000 to the church. They will sell it with no capital gains. Of course, you will never pay capital gains, and you kept the cash in your pocket. And you can go use that to invest in something else, a different mutual fund, a different stock, whatever it might be. So that’s another really good technique to do at the end of the year. So those are just a couple of housekeeping ideas.

One other thing I forgot to mention was qualified charitable distributions. We may or may not have talked about it in the past, but basically using your required minimum distribution that you have to take out when you’re over 70 and a half, using that distribution, sending it straight to charity. And you get the full deduction. You don’t have to pay taxes on it in other words. And you can, again, use your cashflow. Instead of giving it to the charitable organization, you can keep it for yourself. And you have given away your distribution to them. Effectively, your net worth’s not changing, but you’re not paying taxes on that distribution you normally would have. Because think about it, some people aren’t able to write off their charitable donation due to various circumstances, tax brackets, all those different reasons. And so this enables you to take that distribution out and give it away without any taxes to you.

So those are a few little tips, tax swaps, donating your appreciated securities, and doing qualified charitable distribution. This is the time of year to be doing that. We still have obviously time. We have three weeks or so till the end of the year, so you still have time to do all these things. So make sure, of course, if you need help with any of that, we can look at your portfolio and advise you on those types of things. (210) 526-0057 or you can always reach out to us on creatingricherlives.com, and we’ll be glad to help you.

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