Implementation
During the accumulation phase of your investment plan, you want to reduce the impact of taxes. If you are in the 28 percent tax bracket (or higher), consider a municipal money market fund for your short-term funds. The dividends of the municipal funds are federal income tax exempt, and in some cases you can obtain funds that are state tax exempt if your state has an income tax. For your medium-term funds, consider a municipal short-term bond fund for the same reason. For your long-term portfolio, consider placing investments that generate dividends or capital gains distributions into tax-favored plans such as an IRA or a 401(k) retirement plan. Since you don't need the income to meet your basic expenditures but only are planning to reinvest those profits, you should generally try to defer the taxes as long as possible.One of the best ways to help implementation of your investment strategy work is to put as much of your investment program on "autopilot" as possible. You can use allotments, automatic checking account withdrawals, and mutual fund automatic investment plans to enforce the savings commitment you made when you developed your budget.
Monitoring and Rebalancing Your Portfolio
Because asset classes react differently to existing economic conditions, you should periodically check the values of each asset class to see if they are still in line with percentages you have chosen. In all likelihood, some investments will have done so well that their percentage of the long-term portfolio has grown. To reachieve the desired asset allocation, you can either add new funds to the assets to bring them back up to the desired percentage or sell some of the investment that has done well to bring it back in line with the desired asset allocation. Keep in mind that if you sell a mutual fund that has done well, you will incur tax on the capital gain, so adding new funds is the more efficient option. If the funds are in an IRA or 401(k), you can move money between accounts without immediate tax implications, provided you never take possession of the funds.
Doing such rebalancing once or twice a year is adequate in most cases. Your portfolio rebalancing should be done at the same time as you review your goals and your need to move funds either from the long-term to the medium term portfolio or from the medium-term to the short-term portfolio. Doing so will make for a much more efficient means of achieving the desired asset allocation. The goal would be to minimize the number of selling transactions to defer paying capital gains on the profits. Thus, newly accumulated funds (from your income or from having dividends and capital gains sent to a money market fund instead of automatically reinvested) can rebalance your portfolio without incurring additional taxes. Once you've made the necessary switches you can forget about your plan until the next year. The peace of mind of knowing you have a workable plan will make you and your family confident that you will achieve your financial goals.
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