Tips on Rebalancing

Are your investments not in the proportion you have as targets?  Is one asset out preforming another?  If you answered yes to these two questions it may be time to take a look at your investments and rebalance.  Now many people rebalance either at the beginning or at the end of the year but there is no reason why someone cannot rebalance when the advantage it to their benefit.

While investing is meant to be a long term undertaking there may from time to time be advantages to taking certain moves that are tax advantageous.  As equities have been moving in an upward direction since mid-2009 it may be time to harvest some of the gains that have been experienced and in contrast to that it is a good tax practice to also harvest losses to offset the gains.  There is no reason to always wait until the end of the year to perform these tasks as the gains may not be there as well as the losses.  Take advantages of these situations when they occur and do not be a slave to a calendar.  While almost all equities have seen tremendous increases in the last five years there are some areas that have been lacking in gains over the last few years where someone can harvest losses.  Emerging markets have been hit hard as the Federal Reserve eases its bond buying causing it to be more expensive for these markets to obtain cheap capital resulting in a decrease in their market prices.  Also fund or ETF that is associated with gold or the production of gold has been hit hard over the last three years.  And finally what used to be fast growth smaller companies have seen a decrease in their market value in the last year.  If someone were in need of losses in equities these three areas would provide excellent opportunities for loss harvesting.  If someone does harvest losses they need to remember the wash-sales rules by the IRS.  And that is if someone were to sell an equity at a loss they must wait at least 30 days before buying the equity back.  If someone does repurchase the equity prior to the wash-sale rule completing the 30 day wait period the loss is negated for tax purposes.  A way around this it to sell an equity that operates in a specific industry a fund that invests in equities in that industry is an acceptable replacement for the original equity.

Another reason it is important to rebalance is it does actually increase the returns on your portfolio by as much as one percent a year.  Over time that can really make a difference in the value of the portfolio.  Over the last five years equities have seen double digit returns on average while bond funds have been relatively flat.  That means that if someone has a desired asset mix of 80% equities and 20% bonds their portfolio is now very much out of balance depending on when it was last rebalanced.  If it has been more than two years since the portfolio was last rebalanced the large increase in the value of equities alone would trigger the need to rebalance.  Some people rebalance annually other more often.  The key factors to rebalancing are how much is the desired asset allocation off and what are the costs associated with rebalancing.  As a general rule when an asset has gains or decreases of 5% or more it may be time to rebalance.  As for how often one should rebalance the commissions and tax implications need to be taken into account before any trades are made.

And finally there are needs to rebalance as one’s risk tolerance changes.  When an investor is younger they may feel comfortable have a higher concentration of their assets in equities.  As they get older they may want to reduce risk by shifting assets to an asset such as bonds.  Generally as one approaches retirement their risk tolerance changes and they become more interested in the preservation of capital and not as much with growth.  But as people retire they do need to remember that many will spend 30 plus years in retirement so equities will still play a vital role in one’s retirement plans.

As costs are a factor in rebalancing as well as taxes it is best to start rebalancing in tax sheltered accounts.  Many 401(k) plans and IRA’s are the best place to begin with rebalancing as the taxes are deferred or not even an issue.  Also in many of these plans the commissions on trades is less than one may expect in a brokerage account.

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