The beginning of a new year is a perfect time for investors to review their finances, do some tax planning, and consider the companies they own in their portfolios. With that in mind, here are three things investors ought to do once the calendar flips to 2016.
No. 1: Run the numbers
Taking the time to consider how much money you have in assets and what you owe in debts allows you to see whether your net worth, or your total assets minus your total liabilities, is on track to achieve your retirement savings goals.
Overall, the median net worth of the average American is $81,200. However, it's typically recommended that investors draw down no more than 4% of their savings in retirement for income, so if your net worth is greater than that of the average Joe, don't pat yourself on the back quite yet.
Instead, take some time to think about how much income you'll need in retirement. (Hint: The average retiree spends between 70% and 80% of their pre-retirement income per year.) Then, calculate to see if the amount you're putting away every year will get you to that number. For example, using the 4% rule, a portfolio valued at $1 million would provide annual income of $40,000 and a portfolio valued at $500,000 would provide annual income of $20,000.
Tip: Don't forget to include Social Security income in your retirement income calculation. The average retired worker will receive $1,341 per month in Social Security payments in 2016.
No. 2: Max out 2015 IRA contributions
When you're done crunching those numbers, it's time to take a look back at your 2015 income to see if you can put more money into your Individual Retirement Accounts (IRA) before the tax filing deadline in April.
In 2015 and 2016, the contribution limits for a Roth IRA and traditional IRA are $5,500. An additional $1,000 can be contributed to an IRA if you're above 50. However, remember that not everyone can contribute to an IRA and get the tax savings associated with them.
For the 2015 tax year, the tax deduction benefit of a traditional IRA begins phasing out at $68,000 for individuals with a retirement plan at work. If you're married filing jointly and one of you has a retirement plan through work, the tax deduction benefit of a traditional IRA begins phasing out at $98,000.
Roth IRAs that allow you to contribute taxable money up front for tax-free income in retirement also restrict how much money you can contribute to them based on income. For the 2015 tax year, the ability to contribute to a Roth IRA begins phasing out at $116,000 for individuals and $183,000 for people who are married.
If you're self-employed, don't forget the potential tax benefits associated with a simplified employee pension IRA (SEP-IRA). In 2015, business owners can salt away the lesser of 25% of their income or $53,000. Like a traditional IRA, contributions to a SEP-IRA are tax-deductible up front and contributions can be made up until April's tax filing deadline.
No. 3: Review holdings for diversification and quality
The New Year is also an excellent time to reacquaint yourself with your investments. The post-Great Recession bull market may have left you a bit complacent about the stocks you own and the weightings of your stocks relative to the value of your entire portfolio.
First, see if the percentage of your money invested in stocks is in keeping with your risk tolerance. Generally, increasing your exposure to different sectors, industries, and various types of investments, such as bonds, can lower the chances of a bear market derailing your future retirement income. This is very important as you get older and have less time to make up for inevitable market corrections. For that reason, trimming your exposure to riskier industries, such as biotech and small-cap stocks, can be a smart move as you approach retirement.
Once you've decided if you're comfortable with your portfolio's overall exposure to risk, it's time to evaluate each individual investment to make sure it still deserves a spot in your portfolio.
Some questions an individual stock investor can ask to determine this include:
- Is the company I own executing on its current business plan by growing its revenue and profit?
- Does the company's plan for the future, such as new products or services, make sense to me?
- Is the company financially healthy, with plenty of cash on the books and the financial flexibility to cover its obligations?
Answering these questions sheds light on whether any changes should be made to your holdings, but remember to approach this process unemotionally. You may have lost money on some stocks that no longer deserve to be in your portfolio, but it's often better to swap out a losing investment that no longer meets your objectives for one that does.
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