As of December 31, 2012, we received an announcement from President Barack Obama that Congress is close to reaching a deal on the fiscal cliff. Markets have been quite volatile in December awaiting news on whether a deal regarding tax rates and government spending would be reached. The Dow started December around 13,000, rose to 13,300, and fell back to 13,000 based on how the fiscal cliff negotiations were going. The basic framework of the fiscal cliff negotiations is that the top tax rate will rise from 35% to 39.6% for individuals earning $400,000 or families earning $450,000. Taxes on dividends will remain at 15% for those under that threshold but will rise to 20% for those over that threshold.
Now that we have some clarity regarding where taxes on incomes and dividends will be, I’ve been thinking about my IRA positioning for 2013. Should I invest in equities, bonds, gold, REITS, housing stocks, foreign stocks, or technology stocks? For the average investor, the name of the game is diversification. With an IRA, that can be accomplished by allocating capital to mutual funds. Ideally, you’ll want to hold positions in an equity fund and bond fund based on your “risk appetite” which depends on your age and investing style. If you are younger and not worried about risk, you’ll want an IRA portfolio with the majority of its holdings in an equity mutual fund or individual stocks, particularly growth stocks. If you’re nearing retirement, you’ll want an IRA portfolio with the majority of its holdings in a bond mutual fund. Exposure to dividend-paying value stocks or “blue chips” is also advised.
I’m a younger investor and can take on more risk so capital growth is more important than capital preservation for me. I’m going to be putting the majority of my IRA funds into equity mutual funds in 2013. With interest rates at historically low levels, this era of ultra-low interest rates will only last for a few more years. It’s inevitable that interest rates will rise, although it may take some time for that to happen. When interest rates rise, bond prices fall, which is why I am going to be avoiding bond mutual funds all together in 2013. If you would like some bond exposure, I would recommend being in short-term bonds only. In the event that interest rates rise, short-terms bonds will not be affected as much as long-term bonds.
If you’re a more experienced investor, you may also want to look for stocks that can benefit from the “January effect.” In December, underperforming stocks with significant losses got hammered to the downside. In December, investors will sell their stock positions with losses to offset their gains. Investors also sold some of their winners to book gains in 2012 when their taxes would be lower in comparison to 2013.
The best example of a stock that was a great performer in 2012 that got hammered in December, which I believe to be mostly due to selling for tax reasons, is Apple ($AAPL). In 2012, Apple started out around $400 a share, rose to $700 in September, only to decline to $500 by the end of the year. On December 31, Barron’s released an article claiming that Apple is undervalued and the stock jumped 3.8%. With Apple trading at a PE of 12, which is below the PE of the S&P 500, it looks like a bargain at $525 where it’s currently trading. I initiated a position in Apple today which I expect to outperform the market in 2013 like it did in 2012. I believe the sell off from September presents a tremendous buying opportunity for investors.
On the other end of the spectrum, two examples of stocks that were hammered by year-end selling to claim losses rather than gains are $ZNGA and $AMD. AMD dropped from $8 to $2.33. ZNGA dropped from its IPO price of $10 and a high of $15.91 to $2.30. I believe both stocks could be due for a rebound in 2013 due to the “January effect.” Where oversold stocks from year-end tax selling bounce back in the month of January. The same theory applies for any stock that posted a significant loss in 2012, which accelerated in the last quarter of the year.
Remember that you’ll be able to contribute $5,500 to your IRA on January 1, 2013. Good luck investing in 2013 and have a Happy New Year!