Year-End Portfolio Tweaks for an Unusual Year
What not to do with your investments and taxes is just as important as what to do.
Bloomberg, December 21, 2020
At this point in the typical year, this column would be filled with all the usual personal financial advice: max out the contributions to your 401(k) and 529 savings plans, add to your health savings account, make year-end charitable donations and make sure to rebalance your investment portfolio.
But 2020 was not a typical year, and the usual financial advice won’t do. The reason is obvious: The pandemic changed life as we knew it, from market to politics and everything in between.
Highly Appreciated Stocks: This is a good problem to have. The pandemic and lockdowns created enormous and unexpected stock winners this year. For example, vaccine developer Moderna, Inc. soared 617%; work from home facilitator Zoom Video Communications Inc. surged 406%; and remote document manager DocuSign Inc. gained 215%. If you were fortunate to be in some of the small healthcare stocks, you might be wondering what to do with the eye-popping gains like that of Novavax Inc., which exploded higher by 3,037%, or Vaxart Inc., which rocketed up 2,000%. And many know about new S&P 500 Index member Tesla Inc., which has returned 731%.
These and other stocks with big gains are creating portfolio management risks that should be addressed. When a single winner balloons to 30%, 40% or even 50% of a portfolio, it becomes too much of a good thing in that too much of one’s assets may be tied to a single stock. Most investors will have a hard time sleeping well when half of their net worth swings up and down like a chimpanzee who just discovered cocaine.
The simplest solution is to sell a large chunk of the big gainers and rotate the proceeds into a broad exchange-traded or mutual fund. Recognize what this exchange accomplishes: you are giving up the potential for further gains (of which there is no guarantee) and paying capital gains taxes in exchange for more balance and far less volatility.
Those who have difficulty psychologically making the pivot from wealth accumulation to wealth preservation, try thinking about it within the framework of regret minimization. 1 The key is not letting a good problem become a bad one.
Donor Advised Fund Contribution: If all of the volatility that coked-up chimp managing your portfolio creates is okay, then consider another option: Give it away.
Hear me out: You can use some of that wildly appreciated stock to make an “irrevocable contribution” to a donor-advised fund account, 2 where it will be invested and grow tax-free. You can direct grants from that account to any qualified charity now, or at any time in the future. And, you will receive the maximum tax deduction allowable by the Internal Revenue Service for this calendar year – up to 30% of your adjusted gross income, with any excess carrying forward for up to five tax years. This can be structured to offset the capital gains for the diversification trade recommended in the previous section.
You had a good year! Make it even better by spreading some joy to where it can do some good.
Corona Virus Related Distribution: For those of us not sitting on “10-baggers,” 2020 brought other relief: Section 2202 of the CARES Act provides for “expanded options and favorable tax treatment for up to $100,000 of coronavirus-related distributions.” What this means is that you can borrow up to $100,000 dollars from any of your eligible retirement plans.3 As long as you use the proceeds for Covid-related “health or finance” expenses – a very broad area – you can repay it over three years without penalty. Prior retirement account loans can be extended by a year without penalty as well. 4
Beware of Home Office Deductions! Here’s what NOT to do: Unless you meet very specific circumstances that the IRS is looking for, don’t plan on making a huge deduction for that home office you have been working in since March. The Tax Cuts and Jobs Act of 2017 eliminated many ordinary business expense deductions, including miscellaneous itemized deductions, for employees covering the years 2018-2025.
Anyone who receives wages on form W-2 cannot deduct home office expenses. If you are self-employed and your home office is your primary workplace and used exclusively for business – and not just a laptop in the den – you can deduct a pro rata percentage of costs, including upkeep, mortgage payments, utilities and insurance against business income. Speak to your tax professional about how to stay on the right side of the bright line here.
This has been a unique and, in so many ways, a terrible year. If you take full advantage of the circumstances, you can at least remove some of the financial sting of 2020.
1. Which result would be more painful: Not selling and watching the big holding crash, or selling a large chunk some and seeing it continue to rise? The answer to that can help you solve the what to do issue.
2. Donor Advised Fund Contributions make up about 12% of individual giving, according to the National Philanthropic Trust, a public charity that makes grants and sponsors a DAF With grants of $23.4 billion in 2018, these funds are the fastest-growing form of philanthropy.Contributions to these funds grew 20.1%to $37.1 billion last year and assets reached $121.4 billion, up from $112.1 billion in 2017.
3. Such as Individual Retirement Accounts or corporate retirement plans, including 401(k)s and403(b)s.
4. The IRS defines these qualified individuals as those “diagnosed with COVID-19, or have a spouse or dependent is diagnosed with COVID-19, experience adverse financial consequences as a result of being quarantined, furloughed or laid off, or having work hours reduced due to COVID-19, or as a result of being unable to work due to lack of child care due, or as a result of closing or reducing hours of a business that you own or operate due to COVID-19.”