This is the time of year when investors should be reviewing their portfolios, both non-retirement and retirement plan investment balances, and rebalancing their asset allocation based on the performance of the past year. 

For example, with the Dow Jones Industrial average increasing 11% this year through December 29, investors with large-cap exposure should now consider paring back this asset class and reinvesting sales proceeds in another asset class that did not fare as well.

Review and Rebalance

Similarly, investors in a Russell 3000 sector experienced a 13% valuation gain year-to-date in 2010; reviewing a diversified portfolio's exposure to growth and value styles, mid cap, international emerging markets, corporate and government bonds, and cash is a very appropriate undertaking with the advent of the New Year.

Rebalancing the portfolio should always be based on investors' risk tolerance; desired rate of return (measured by income and yield); their investment timeline, for example, to fund college expenditures that commence in six years; and their current and expected cash-flow needs. As a general rule, if they have a financial goal to fund in five years or less, they should avoid investing in equities. 

To Do List: Before Year-End and in the New Year

Recognizing gains and redeploying the proceeds to rebalance investors' diversified portfolios should be done by Dec. 31, 2010, along with recognizing losses as well, to offset taxable gains.

Where no realized losses exist, consider selling appreciated positions early in January 2011, and defer the tax due on the gain until April 15, 2012—the due date for 2011 income tax returns. Remember the 15% long term federal capital gain tax rate continues into 2011 and 2012.

For investors that desire yield, consider investments in dividend-paying preferred stocks, since the 15% qualified dividend federal tax rate also continues into 2011 and 2012.

Should Investors Prepay 2010 Estimated State Tax Now for the Federal Deduction?

Review now clients' estimated 2010 federal and state income tax liabilities. If they have a 2010 state income-tax liability due on April 15,  2011 (when they file their 2010 income tax return), and they itemize deductions and are not in Alternative Minimum Tax (AMT), consider having them prepay the 2010 state income tax due by Dec. 31, 2010, to obtain a 2010 federal income tax deduction, and realize federal tax savings at April 15, 2011.

Give to Charity, and Get the Deduction

Also consider charitable gifts by Dec. 31 to reduce clients' federal income-tax liability. Remember, if they convey appreciated publicly traded stock to charity, their deduction is for the fair value of the stock—not the amount paid for the stock—therefore the appreciation is tax deductible. 

Lastly, if clients want to make a gift to a family member or friend in 2010, they can do so on or before Dec. 31, 2010 in the amount of $13,000 (per recipient) without incurring any federal gift tax; if they are married this amount is increased to $26,000; and again, for this purpose they should consider gifting appreciated property.

The preceding tax and investment observations are general in nature, and may not be appropriate based on clients' facts and risk tolerance. Further, the observations cannot be relied upon to avoid any federal income tax penalties; therefore, always consult with a qualified investment and tax advisor before you make any related decisions.