Time for a Portfolio Tuneup

Year-End Is an Opportunity to Make Moves and Minimize Taxes

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NEW YORK -- The final weeks of the year offer mutual fund investors an opportunity to make changes in their holdings. It's worth taking the time because a few deft moves now could make way for big gifts: smaller tax bills and more-rounded portfolios.

Many mutual funds are now letting shareholders know what to expect of their year-end distributions. Despite the markets' recent skittishness on fears that a weak housing market and soured loans would slow the economy, many fund investors reaped sizable gains for the year.

But too often, investors cheer the winners and stick reports from poorly performing funds under stacks of holiday mail instead of considering playing the good against the bad to minimize taxes.

Holding on to investments that gained big in 2007 -- such as China and Latin America funds, which are off their highs but still up more than 50 percent -- and selling some weaker players could diminish what is owed the government because a loss on one fund can offset income, and in turn, taxes owed, on another.

"It's time to clean house and get rid of that driftwood," said Tom Roseen, an analyst at Lipper, which tracks mutual funds. "A lot of people don't think of this until April 15, and by then it's too late."

Investors have surrendered an average 1.4 to 2.3 percentage points each year in the past 10 years to taxes, according to Lipper. "It makes a great deal of difference," Roseen said .

Although most investors shouldn't try to orchestrate these kinds of moves without a tax consultant, taking a fresh look at where the money sits is good for everyone, even investors in 401(k) plans and other tax-sheltered investments.

Taxes aren't the only reason to re-examine your portfolio. You might find you'd be better off reallocating some of your assets.

Perhaps a holding such as a natural resources fund has become too big in an investor's portfolio given that many such funds rose more than one-third this year. Although it can be difficult to walk away from strong performers, the growth won't keep pace forever, and taking some money from winners and putting it in corners of the market that might be ripe for acceleration could bring benefits.

Just recall the fate of many tech investors at the beginning of the decade. Those with outsized holdings in technology stocks who rebalanced their portfolios at the start of 2000 would have walked away with huge gains. Soon into the new year, the dot-com bubble began its implosion, revealing how overweighted many investors had become in tech. Maintaining proper asset allocation doesn't mean investors will sidestep every pitfall, but it will mean they'll likely be better prepared when the market stumbles.

"We love to brag about our good funds, but we have a tendency to ignore our bad funds. We could actually take some of that money that's not working so well for us and put it back to work with good-performing funds," said Roseen.

Stephanie Ackler, head of Ackler Wealth Management at Wachovia Securities, said the final weeks of the year are also a good time for investors to make charitable contributions and give to, say, tax-sheltered college savings funds.

She said that this year, in addition to assessing their tax situations, many investors have come to her eager to revisit their asset allocations, given the markets' volatility this year.

"People have seen a lot of shifting valuations on their portfolios, and I've had a lot of folks come in and the topic comes up of risk tolerance. They'll say, 'Maybe I'm going to sleep better at night shifting into fixed income.' "

She isn't necessarily prescribing huge changes to portfolios, just tweaks in case investors find certain positions have grown too large, for example.

"Maybe we can sell off a portion of those to reinvest in other areas," she said. "It's just skimming the cream off then letting it rise again."