You do not want to rebalance too frequently, and you certainly want to be aware of whether doing so will generate taxable income. Rebalancing with added cash has its advantages. This can limit the number of trades you need to make (and thus trading costs) and minimize taxable capital gains. You may want to delay rebalancing if it incurs short-term capital gains, as they are taxed as ordinary income. If capital losses can be harvested, you want to take advantage of that situation.
Let’s look at a brief, hypothetical example of how rebalancing works. Ron and Sally set a desired asset allocation of $500,000 of equities and $500,000 of fixed income for their $1 million portfolio. Their target is to stay within 5% of this 50% stock and 50% fixed income mix. Over the past two years, equities have performed well, and this portion of their portfolio has grown to $700,000. Their portfolio’s fixed income value also has risen, to $530,000. They now have a portfolio worth $1.23 million with 57% in equities and 43% in fixed income. This new allocation has too much risk for them, and they decide to sell $85,000 of equities and reinvest that cash into fixed income to restore their original 50/50 allocation.
Another benefit of knowing your portfolio is built to maintain a risk profile that you can tolerate is the calm and peace of mind it will lend you in years like 2020, when volatility has been higher than in the recent past and abandoning stocks may have looked tempting.
Using a diversified portfolio that you monitor and rebalance periodically will help you stick to your investment strategy and manage your risk.
This commentary originally appeared August 2 on TheCasperStarTribune.com
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