Being a proactive investor means paying attention to more than just your investments’ fees and expenses. What your dividends yield is very important. And their tax situation is, as well, as dividends are taxable income.
A relatively easy way to navigate this is by investing in sectors of the world’s most tracked stock index, the Standard & Poor’s 500. Though never intended to be a tool for investing, the S&P 500 certainly has become one. Originators developed the index as an indicator for economists when comparing various sectors of the U.S. economy, such as agriculture, manufacturing or technology.
The index’s creators based the design on the theory that the economy vacillates between market peaks and bottoms, expanding and contracting cyclically. Market ratings and analysis giant Standard and Poor’s was commissioned almost a century ago to identify American companies representing various sectors that presumably performed differently, based on the economic shifts.
As a broad example, companies in the utilities and consumer goods sectors usually perform well when the economy falls into a recession. Likewise, industrial companies ought to do better when the economy expands.
While most financial professionals dismiss the S&P 500 as a reliable investing indicator, often because it represents only the very largest U.S. companies, the index nonetheless continues to serve as a central measure of investment performance.
Today’s S&P index comprises nine sectors of stocks: technology, financials, health care, consumer discretionary (such as entertainment and restaurant companies), industrials (such as makers of aircraft or heavy machinery, among others), consumer staples, energy, utilities and materials.
The difference between one sector and another can be substantial when it comes to your money.
Let’s say you are a passive investor who buys stock or shares of funds and then holds your investment, making no effort to buy or sell with market fluctuations. You simply own a slice of an exchange-traded fund that attempts to replicate the performance of the S&P 500. Let’s also say that you keep an equal amount of money in your individual retirement account and in your taxable brokerage account, each owning shares in an ETF that tries to track the S&P 500’s performance.
Becoming proactive from a tax and investment perspective can put money in your wallet. Currently, the dividend yield (compared with how the fund did 12 months ago) in the Select Sector SPDR ETF (XLY), representing consumer discretionary stocks in the S&P 500, is 1.24%. The yield of the similar health-care ETF (XLV) is 1.27, the energy sector ETF (XLE) is 2.35, the financials ETF (XLF) is 1.63 and so on.
(Your investments’ yield and returns differ. Yield is a forward-looking assumption based broadly on past performance. Return expresses what you actually earned on your investment during a certain span in the past, including interest, dividends paid to shareholders and increases in the share price.)
Obviously, some sectors can make you more than others, even if the difference in various funds’ yields is a percentage point or less. When you must pay taxes on that income, strategic positioning of your assets becomes even more important – especially if you earn enough to be in a marginal income tax bracket where your income above the minimum to qualify for the bracket incurs additional tax.
Remember that you pay tax on income from your taxable investments, including capital gains if you sell holdings. Your 401(k), 403(b), traditional IRA or Roth IRA grant you a tax break when you contribute or when you withdraw after reaching a minimum age.
One good strategy: Rebalance your portfolio to put the higher-yielding sectors in your tax-deferring IRA and the lower-yielding sectors in your taxable accounts. Your investment profile remains the same but you give less of your money to the tax man.
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Joseph “Big Joe” Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at firstname.lastname@example.org, or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.
Securities offered through and by World Equity Group Inc. Member FINRA/SIPC. Advisory services can be offered by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.
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