Posted by Abundant Wealth Planning LLC

Tax-Wise Portfolio Rebalancing

Tax-Wise Portfolio Rebalancing

Studies indicate that the intelligent allocation of assets can lead to long-term investment success. Individuals can find the desired mix of the more risky asset class, such as stocks and assets with a relatively lower risk, such as bonds. Sticking to a chosen strategy could provide acceptable returns for volatile assets and fewer fluctuations from stable assets. An asset allocation may consist of a simple combination of stocks and bonds and an emergency cash reserve. Alternatively, the sale of asset allocation may include different assets, from small businesses domestic stocks to real estate and international mega-companies.

Investors can create their asset allocation or can work with an investment professional. In any case, the challenge is to maintain the desired destination by the ups and downs of financial markets. The answer recommended by financial advisors is to rebalance your portfolio periodically.

Buy Low, Sell High 

Once asset allocation is in place, it is possible to review at regular intervals or after major market movements.

Example 1: John has a basic asset allocation of 60% in stock and 40% in bonds. However, the bull market has changed his portfolio to 75% in stocks and 25% in bonds. John is uncomfortable with his great commitment to stocks, which have crashed twice this century.

The solution would be for John to move money from stock to bond, going back to his previous 60-40 allocation. Many investors are reluctant to follow this plan, leaving a very promising market for one that is out of favor. However, historically, investors who continue the dynamics of the market, buying what was popular and selling it off when it has been devalued, have received subpar results. Going against the crowd by selling low and buying high may turn out to be more efficient.

Tax Trap

Rebalancing is an inefficient tax process. Investors always sell assets that moved above the desired location, which generally means taking a profit. These benefits can be subject to tax and can increase a person's reluctance to rebalance.

How can investors rebalance their business asset allocation without feeling overwhelmed by taxes? Here are some possibilities:

Clenched fist: As long as you hold the securities for more than one year (12 months), profit on a sale will benefit from long-term capital gains that are lower than ordinary income tax rates. To pay for some tax can be useful if it reduces the risk of the portfolio.

In addition, if John has a mix of shares and capital funds, he could selectively sell long-term stocks in the least appreciation, resulting in the lowest tax bill, unless he thinks there are investment reasons for selling his big gainers.

Do not sell if there is no sale; no tax will be due.


Example 2: Suppose the John portfolio consists of $100,000 in securities and $300,000 in shares. Instead of selling stocks, John could hang on to them and avoid taxable sales. At the same time, his future investments could go into bonds; the dividends from John's stocks funds or and stock could be invested in bonds funds and bonds. Gradually, the allocation of John's assets would increase from 75-25 to 70-30 to 65-35, towards the objective of 60-40.

Suppose John is retired, spending down his investment portfolio instead of building for the future. In this situation, John could tap his stocks for income, which reduces his allocation. To hold down taxes, John could liquidate stocks selectively.

Bank Losses

Investors can have multiple positions in individual stocks and funds, including some who have lost their initial purchase value. For example, stocks and healthcare stocks generally had losses in the 2016 fiscal year, even though the broad market had gained. If significant prices on specific holdings drop, a sale can generate a considerable capital loss, which will probably make rebalancing easier in the future.

Use tax-favored pension accounts.

Taking benefits from plans, such as 401(k) and individual pension accounts (IRA), will not generate current taxes. Therefore, John can do some or all of his rebalancing, tax-free, by moving within his IRA from stocks to bonds. This effective tax contribution can be a factor to consider when deciding whether some investments should enter a deferred tax or taxable account. In possession of a mix of asset classes on both sides can allow more efficient tax rebalancing.

The methods listed here are not mutually exclusive. You might find out that combining tactics will help you rebalance and maintain your asset allocation without activating steep tax bills.



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