What Nothing Tells You About Rebalancing Your Portfolio
When investing, it’s important to adjust your asset allocation so it continues to align with your goals and risk tolerance, and rebalancing can help you stay on track.
Rebalancing refers to buying and selling assets in your portfolio to maintain the correct allocation. For example, if you target a portfolio of 60% stocks and 40% bonds but the stock market is rising and 70% of your portfolio is now in stocks, it’s time to sell some stocks.
How you rebalance your portfolio will determine how much you pay in taxes. Doing it wrong can lead to unnecessary expenses, but there are a few rules of thumb that can increase your savings.
1. Don’t rely on emotions
Rebalancing should be in order. Investors who buy and sell due to scary market headlines and sharp corrections risk missing out on long-term growth opportunities and exiting quality positions early. Having a fixed schedule, such as a quarterly or annual portfolio review, keeps emotions out of the decision-making process.
You can assess your current financial situation and assess whether your portfolio construction meets your long-term goals. Some retirees may reduce growth-oriented assets and focus on fixed-income investments to reduce volatility and risk. However, the decision should not be based on how the stock market has performed in the past month. Long-term financial goals and your risk tolerance are important variables that should influence how you rebalance your portfolio.
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2. Prioritize tax-advantaged accounts
When rebalancing, make sure you understand what will create a taxable event. Rebalancing in tax-advantaged accounts such as 401(k) accounts and individual retirement accounts (IRAs) is not taxed, but doing so in a taxable brokerage account may be. If you can – and it fits your overall plan – prioritize selling goods in tax-advantaged accounts instead of your retail account.
When investors are living off their portfolios, it often makes sense for them to make traditional withdrawals from their traditional 401(k) and IRA plans to spread the tax impact over several years. You can avoid higher tax rates by tapping into your brokerage and Roth accounts if applicable. Withdrawing some money from your traditional retirement plans between retirement and collecting your first Social Security payment can also help.
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3. Use assignments
You don’t need to sell the winnings in a taxable brokerage account to diversify your holdings. Investors may choose to receive dividends as cash instead of reinvesting dividends in additional shares. People following this strategy can invest dividend income in underperforming assets in their portfolios.
This strategy allows you to rebalance your portfolio without selling your assets, which can lower your tax bill.
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4. Use tax loss harvesting
Tax loss harvesting is a strategy that involves selling investments at a loss to offset gains elsewhere in your portfolio in order to lower your tax bill. Tax loss harvesting is more popular later in the year, when investors will sell losing stocks and buy elsewhere.
Just be aware of the wash-sale rule from the IRS that prevents you from selling an asset for a tax loss and immediately buying the same or a very similar security within 30 days before or after that sale. Harvesting tax losses can be difficult, so consider contacting a financial advisor or tax professional to help you with your plan.
