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As a nation, we’ve been through some pretty rough times this year. It’s kind of hard to figure out exactly where things went wrong, since the whole thing began with such promise. Y2K came and went, and city lights didn’t go out, no satellites (or planes) fell from the sky, and McDonald’s was still serving billions each day. Life was good, and for many of us, the record gains in the stock market made it even better. In March, we all looked at our portfolios and thought one of two things: either “Wow, I’m going to be rich!” or “Wow, I really have to get into this market!” Nasdaq 10,000 did not seem that far out of the realm of possibility. I don’t know exactly where the whole thing went south, but the Summer Olympics turned out to be a real bore, our presidential election turned out to be a litigious comedy of errors, and some markets didn’t simply lose momentum, they lost half their value. So if you’re looking at your portfolio and seeing one of the worst performing years in the past few decades, you’re not alone. Though you may be horrified — or, at the very least, profoundly disappointed — the year isn’t quite over. It’s not too late for even the most passive investors to benefit from a few tweaks of the portfolio. You still have three weeks, so finish reading this article and get going. There’s money to be recovered! REALIZE LOSSES You don’t have to feel like a big, lonely loser if you made some investments that went down in value. With the volatility of this year’s stock markets, many of us — yes, that includes yours truly — made investments that are currently in the red. As astute investors, we can choose to do nothing until our beloved holdings recover, or we can sell and use these losses to offset gains from other sales, to offset mutual fund distributions, or to offset a portion of ordinary income. First, understand that there are two types of gains and losses: short-term and long-term. Short-term gains and losses are from sales of securities that are held less than one year, while long-term gains come from the sale of investments held longer. To encourage all of us to become long-term investors, long-term gains for all but those in the lowest of tax brackets are taxed at 20 percent, and short-term gains are taxed at the rate of ordinary income, up to 39.6 percent in some cases. Let’s say you have gains from the sale of stock or from mutual fund capital gain distributions. You may offset these gains, dollar for dollar, with losses. Because short-term gains are taxed at a higher rate than long-term gains, it is usually best to reduce short-term gains first by realizing short-term losses. Don’t forget that states whose residents pay income taxes will receive their fair share from remaining gains. A (SMALL) BONUS You may have losses in your portfolio that exceed other gains. If you sell and realize these losses before the end of the year, any excess loss (greater than your gains) will carry forward to 2001. For the current tax year, however, you may apply up to $3,000 of your excess loss against your ordinary income, which is usually taxed at a higher rate. For those in the top federal tax bracket, this translates to savings of nearly $1,200. BITE THE BULLET At the end of the year, many investors find themselves able to realize losses but hesitate to sacrifice their sacred holding, worrying that it might suddenly increase in value. You can wait at least 31 days and then buy back the same security. Note: If you sell for a loss and buy back the same security within 31 days, the IRS will not allow you to deduct the loss. You can, however, buy a similar security immediately. If you own a mutual fund that’s well-managed, you can sell the fund for a loss and buy another fund run by the same manager. In the case of a stock, you can purchase a stock in the same industry with similar prospects. Many investors are using this strategy with telecommunications and optical networking stocks. Keep in mind that if you buy another security too similar to the original, such as an option to buy the stock, the IRS will disallow the loss. MAX OUT RETIREMENT PLANS If you have not done so already, consider making the maximum allowed contribution to your firm’s 401(k). The maximum contribution to a 401(k) by a participant has been raised for 2000 from $10,000 to $10,500. If you would like to save the maximum in pre-tax dollars, you may be able to make up the shortfall on your last paycheck or year-end distribution. Check with your human resource specialist to find out what options are open to you. Keep an eye on limits for 2001 and beyond. Next year, we may see contribution limits increase dramatically. Most of the tax proposals in the works include some provision to increase limits up to $15,000. While this may not seem substantial, extrapolating a 42 percent increase in pretax savings over 20 years can greatly improve prospects for retirement, perhaps adding a few nice optional items to that house in Palm Beach you’ve set your sights on. Also, don’t rule out the nondeductible IRA. Even though you earn over certain limits and qualify for a retirement plan at work, a nondeductible IRA will allow your annual $2,000 contribution to grow tax-deferred. Though eventually, the gains will be taxed at your ordinary income rate, your contributions come out tax-free. See your financial adviser or accountant on this one. You don’t want to take any chances. A LITTLE EXTRA (ON THE SIDE) Sure, your firm has a retirement plan. But if you have income from other sources — writing and speaking fees, for example — which don’t flow through the firm, you may be able to set aside some of those dollars in your own personalized retirement plan. You have until year’s end to set up most retirement plans. The one exception is the Simple Plan, whose deadline passed Oct. 1. Most contributions, however, can wait until your tax-filing deadline. GIVE IT AWAY Should your plans include charitable giving, making that contribution now rather than waiting until January will allow you to use the deduction this year rather than next. One way to further maximize the benefits in charitable giving is to donate appreciated shares of stocks or mutual funds instead of cash. This win-win situation benefits your favorite charity while offering you a way to sell out of that long-held security without incurring the heavy tax burden you’ve been fretting about. By gifting appreciated stock to a qualified charity, you may take a deduction for the full market value. Since the charity pays no tax on the gain, everyone wins (except the government, of course). This process is easier than you think, and can be executed very quickly. Most churches, synagogues, and other nonprofit organizations already have accounts set up to receive your transferred shares. Warning! Don’t gift the charity your loser security. While the organization will still realize the full market value, they have no use for a tax loss. And by gifting a security that has lost value, you lose your tax loss as well. In such cases, consider selling the shares, taking the tax loss, and gifting the cash instead. GIVE IT AWAY, PART II The year-end deadline is also looming for you to give to that other worthwhile cause: your children. You are permitted to gift up to $10,000 each year to any person without incurring a gift tax or using up your lifetime exemption. This can be a very useful part of your overall estate planning strategy. REBALANCE Rebalancing one’s portfolio to achieve an appropriate allocation of assets seems logical and relatively easy. Yet most people don’t do it. Throughout the year, with some assets in your portfolio performing better than others, your mix will eventually change from your original intentions. Over time, your portfolio will become overweighted with securities that have performed well, leaving others languishing to take a smaller role. That doesn’t seem like such a bad thing until you realize that at the end of last year, had we all simply rebalanced our portfolios to our original investment plan allocation, we would have sold off those holdings that had outperformed the others (rhymes with “smecknology”) and purchased others that did not do as well in 1999 (bonds and value). Go back to your original retirement plan formula, assuming it’s still appropriate, and rebalance. If it calls for more bonds, more foreign stocks, or even some technology at this point, make the change. Reallocating based on your needs and risk tolerance is far better than “letting it ride” on well-performing sectors or trying to time the market. Don’t forget that there are many rules and regulations that every taxpayer must follow. The best approach is to check with your accountant or financial adviser to make sure you have the full picture and the right strategy for your individual situation. So make your year-end checklist and start moving. In just a few weeks, we’ll be toasting the arrival of 2001. Barry Glassman is a certified financial planner and first vice president with Cassaday & Co. in McLean, Va. He specializes in assisting attorneys with individual financial planning and helping law firms with evaluating and implementing firmwide retirement plans. He can be reached at [email protected]

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