Editor's note: This story was originally written going into 2023 and has been added to our CNBC Pro white paper vault. This year was nothing short of jarring for investors. The Federal Reserve sharply raised interest rates to tamp down decades' high levels of inflation. Oil prices popped to historical highs, spurred by war between Russia and Ukraine, only to tumble. Even the 60/40 portfolio, divided between equities and fixed income, suffered from sharp price declines from both types of assets. In a year of scarce returns, investors can take steps to shore up their portfolios, create tax alpha and position themselves to capture returns when the opportunity arises in 2023. Here's where to begin. 1 | TAX-LOSS HARVESTING AND REBALANCING Investors experiencing steep declines within their taxable brokerage accounts can dump some of their losing positions and use those realized losses to offset capital gains elsewhere within their portfolio. In turn, this lowers the tax bill investors would otherwise face for those gains. The savings can be sizable, as the capital gains tax rate is 0%, 15% or 20% on assets held for at least a year. The rate is even higher for assets held for shorter periods, and they are taxed as ordinary income. "The focus in November is to get that loss harvesting completed in taxable accounts," said Tom Meehan, president of Edgemoor Investment Advisors. The firm is ranked No. 5 on the 2022 CNBC Financial Advisor 100 list. Loss harvesting also allows investors to thin out concentrations that might have built up over time. Use the proceeds from your sales to rebalance your portfolio. Meehan is using tax-loss harvesting to thin out heavily concentrated holdings in megacap tech shares and then parking some of the proceeds in 1-year Treasurys to wait for the right time to buy stocks. "We take the loss so that the investor gets a more balanced portfolio at year-end, and they're not as devoted to tech as in the past," he said. "The strategy is to be patient and disciplined." Rising bond yields have also kicked off another conversation: Is it time to shop for higher yielding, high quality opportunities in fixed income? Bond yields and prices move opposite one another. Indeed, there was an opportunity cost to owning fixed income assets when yields were at nearly zero, according to Sunitha Thomas, senior vice president at Northern Trust. "But now you can buy T-bills at 3% to 4%, so we are having this conversation about how we should be using that within their portfolios," she said. 2 | CHARITABLE GIVING TO THIN OUT HEAVY CONCENTRATIONS AND HIGH APPRECIATION For the charitably inclined, giving away appreciated assets have the double benefit of thinning out heavily concentrated positions and picking up a tax break. Just bear in mind that you must itemize deductions on your income tax return to take this write off. In 2022, that means your itemized deductions exceed $12,950 — the standard deduction for single taxpayers — or $25,900 for married couples. A gift of appreciated stock out of a brokerage account can be deductible for these donors. By giving away the appreciated assets to a charitable organization, you avoid incurring capital gains taxes you would incur if you sold the positions and donated the cash. "Anyone doing four or five donations of $1,000 to $5,000, have your broker fill out the transfer form and donate the appreciated stock," said Courtney Ranstrom, a certified financial planner and co-founder of Trailhead Planners. Investors feeling particularly generous can use donor-advised funds to simplify their giving. These funds allow you to set aside assets for giving, collect a charitable deduction for the present year and then issue grants to your favorite charities over time. "You can make a multiyear gift," said Nick Strain, a certified financial planner and senior wealth advisor at Halbert Hargrove Global Advisors. The firm is ranked No. 8 on the 2022 CNBC Financial Advisor 100 list. "You might make a $15,000 contribution, get the tax benefit for the contribution now, but make your $5,000 grant out of the donor-advised fund for each of the next three years," he said. 3 | ROTH CONVERSIONS AND "THE MEGA BACKDOOR ROTH" The silver lining of stocks' sharp decline in 2022 is the fact that investors can build up their pot of tax-free retirement savings at a lower cost. A traditional individual retirement account allows savers to invest pretax or taxdeductible dollars, but withdrawals are subject to ordinary income taxes, plus a 10% income tax if you're under 59 ½. By converting the account to a Roth IRA, you pay the income taxes in the present. However, the Roth account grows tax free, and the money can be withdrawn free of taxes, subject to certain rules . Since portfolio amounts are likely down considerably this year, the tax bite isn't quite as bad. Investors also have an opportunity to scoop up high-growth stock at attractive prices, which they can stash in their Roth accounts. "For our clientele, a good part of them are focused on getting more money into their Roth IRA and buying at depressed prices," said Dan Herron, CPA and founder of Elemental Wealth Advisors. "It takes some bravery." Mega backdoor Roth conversions — a strategy once targeted by lawmakers — are also still available to high-income savers. In this case, an investor makes after-tax contributions to their 401(k) plan and then converts that amount to either a Roth IRA or a Roth 401(k). In 2022, you save up to $20,500 in 401(k) contributions, plus $6,500 in catch-up contributions if you're age 50 or over. A "mega backdoor Roth" allows you to save thousands more in addition to that using after-tax contributions, which you can then convert to Roth funds. The catch is that your employer's retirement plan must allow for these after-tax contributions in the first place. 4 | REASSESS YOUR PORTFOLIO'S HOLDINGS November and December are a key time for actively managed mutual funds, as they flag investors to any distributions of capital gains in that time. Though this isn't a problem for people who hold these mutual funds in tax-deferred or tax-free accounts, these distributions can come with a tax bite if the assets are held in brokerage accounts. This year is a notable one for those mutual fund investors, said Allison Bonds, head of private wealth management at State Street. She noted that many active mutual funds have had a negative return in 2022 and are underperforming their benchmarks. "Many investors are also hitting a third whammy: These mutual funds are paying capital gains distributions in the coming weeks," she added. "That could be puzzling to investors: You would think there wouldn't be capital gains to pay out with the year down." However, as mutual fund investors sold off their holdings in 2022, fund managers had to dump their own holdings to cash out the departing shareholders, which incurs capital gains. That leaves the remaining investors holding the bag on those distributions and paying taxes on them. This development makes exchange traded funds more attractive due to their tax efficiency. "We have been advocating it all year long, but as we look at these looming capital gains for mutual fund positions, we advocate taking a look now and potentially avoiding a bad situation," Bonds said. Tax-loss harvesting can help offset these gain distributions, but it may also be time to weigh whether that fund has a place in your portfolio. Should it be in your tax-deferred account instead? Or does it make sense to gradually unwind the position by investing the distribution elsewhere instead of back into that mutual fund? 5 | DO A GUT CHECK OF YOUR RISK APPETITE AND YOUR GOALS HEADING INTO THE NEW YEAR This year taught investors to think deeply about their ability to withstand volatility in their portfolios. If you found yourself on the verge of dumping assets and hiding in cash during 2022, it may be time to revisit your plan and take stock of the factors in your control. Not only does this mean rebalancing your portfolio to ensure you're not too heavily skewed to any one asset class, but it also means revisiting your safe havens so that you can sleep at night. "People are really digging what bonds are getting now," said Herron of Elemental Wealth Advisors. Short-term bond funds and certificates of deposit are a couple of the safe corners his more conservative clients are excited about. Another lever for investors to pull is to determine their cash flow needs to ensure they have enough flexibility to withstand tumult without having to bail from stocks at the wrong time. "When we meet with clients to build their plans, the first thing we talk about is 'What is your lifestyle spending? How do we make sure you stay with your plan during volatility and not sell assets for income needs?'" said Northern Trust's Thomas. "It's important to have these conversations now of where their current balance sheet is and where their expectations are in terms of liquidity and goals, and then come up with a strategy before starting the year so you can be well positioned," she added.
