Watch Out for These Year-End Traps

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As the year draws to a close, many investors will celebrate how much better their investments did this year than in 2008. Yet the steps that investors will take in both December and January to protect their profits may have a significant impact on your portfolio.

Getting rid of risk
A recent article in the Wall Street Journal reported that many institutional investors appear to be retreating from risky investments like stocks in favor of low-risk investments like short-term Treasuries. The article cited several factors that could possibly be contributing to the move away from risk, including the fact that professional investors have scored big gains in 2009 as well as a change in fiscal years for investment-firms-turned-banks Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) .

Individual investors face similar issues of their own in managing their investments. Here are a few things to watch out for in the coming weeks, along with some tips on how you can prepare and take advantage of them.

1. The taxing process of taking profits
During most years, you have to beware of cross-currents near year-end that result from tax-loss harvesting. Shareholders sitting on big losses often sell their shares during November and December, hoping to use them to offset taxable gains on their winners. The resulting selling pressure can push share prices down even further.

This year, though, losing stocks are few and far between. Instead, stock investors who were smart enough to invest at lower prices earlier this year are sitting on some substantial gains. Yet if they get skittish about wanting to preserve their windfall and therefore decide to sell their shares between now and the end of the year, they'll get a double hit: They'll accelerate the taxes on those gains into this year's tax return, and they'll also pay higher short-term rates on their gains on stocks held a year or less.

For now, that's good news for investors in solid gainers like Wynn Resorts (Nasdaq: WYNN  ) and Fifth Third Bancrorp (Nasdaq: FITB  ) , as the potential tax hit provides a big incentive for shareholders to hold onto these and other winning stocks. That, in turn, may constrain the supply of shares available on the market, supporting prices.

Come January, though, it's entirely possible that those shareholders will immediately start taking profits, knowing that they won't have to pay taxes on those gains for another year. That may serve either as an advance warning sign to existing owners or as a potential opportunity to buy more shares.

2. Banking on the resolution crowd
If you're a long-term investor, what your returns were during any given year isn't all that important in the grand scheme of things. Yet doing regular checkups on your portfolio is a smart move, and it's only natural to use the end of the calendar year as the right time to assess your successes and failures.

As a result, you can expect to see more people doing things like rebalancing their portfolios near the beginning or end of the year than at other times. Given the big moves we've seen this year, a big rebalancing move could have effects like these:

  • Hot sectors like technology and materials could see money flowing out of them, resulting in selling pressure on stocks like Apple (Nasdaq: AAPL  ) and Dow Chemical (NYSE: DOW  ) that have done particularly well in 2009.
  • In contrast, lagging groups like telecom and utilities could gain investor interest, supporting stocks such as Verizon (NYSE: VZ  ) and Southern Company.
  • In the bond arena, corporate bonds have posted extraordinary returns this year, while Treasuries have largely suffered. A move back to lower-risk bonds could create more big waves in the bond market.

The end of the year is a tricky time to navigate with your investments. As long as you're aware of all the factors that influence year-end trading, however, you can make smart moves and get in ahead of the crowd. That will make your New Year's Eve champagne taste all the sweeter.

Are you ready for 2010? Find out from Rick Munarriz which five stocks will beat the market next year.

Fool contributor Dan Caplinger is always looking for traps but keeps a bottle of bubbly on hand at all times for special occasions. He doesn't own shares of the companies mentioned in this article. Apple is a Motley Fool Stock Advisor pick. Southern Company is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is good the whole year 'round.

Read/Post Comments (2) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2009, at 6:00 AM, nivekluap wrote:

    I can hardly wait until January 2nd to move my savings for my Roth IRA to my discount brokerage account and pounce on some bargains that present themselves. Many people lock in some profits for the prevoius year and leave the rest of us some very attractive prices for the long run...thank you!


  • Report this Comment On December 11, 2009, at 11:37 PM, 8Lives wrote:

    What might some of these "very attractice prices for the long run" be?

    KD -- those are my initials as well


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