Saving & Investing
The benefits of disciplined portfolio rebalancing
December 04, 2013
Amy Chain: All right, Mary, I'd like to come to you first. Rebalancing is something that came up quite a bit from our clients. In fact, John from Bel Air, Maryland, wrote in and said, "I'm considering rebalancing the investments in my account. Doing so will trigger long- and short-term capital gains. How should I decide if rebalancing and paying the resulting taxes is the right move for me?" What should we tell John?
Mary Ryan: Well, Amy, this is such an important topic to think about, rebalancing in general. And when we're thinking about year-end and preparing for our upcoming year, as you were just saying, sometimes a lot of other things get in the way to rebalancing. You tend to think, oh, I'll deal with it later. But it's very important to pay attention to it.
And to that point, a lot of times people do hesitate because of taxes. And they think, oh, but if I do this I'm going to incur capital gains and I don't want to do that. And so in a sense, they let the tax tail wag the dog, which we don't want to necessarily do.
So when we talk about rebalancing, we have to look at, one, what your best tolerance is, where you are, what are your goals, what are your overall feeling about your portfolio. And if you're finding that this portfolio is out of balance—and maybe we can touch on that a little bit in another segment—but if you're finding you're out of balance, you really do need to look to make sure that you are taking the profit off the table, taking some risk away.
Now, you can do that. You don't necessarily always have to do that in a taxable account. You can also do it in a tax-deferred account. So maybe look at your IRAs, look at your 401(k), look at other places to take advantage of this rebalancing.
Another thing to think about is, if you have a taxable account, perhaps you have some opportunities to take some losses to go against any of these gains, something we call "tax-loss harvesting," and perhaps you can take advantage of that as well.
But it's very, very important to not let that tax always dictate that you are or are not going to rebalance and, again, always check with your tax advisor before making a huge commitment to something like this, but make sure you are rebalancing. It's a very important part of what you need to do.
Amy Chain: So it sounds like taxes are one consideration when it comes to whether or not you should be rebalancing, but you should really be looking at both your whole portfolio and a longer list of considerations when deciding if and when the right time to rebalance would be.
Mary Ryan: Absolutely. It's a big picture like everything else. It's always a big picture. But you want to make sure that you're not taking on too much risk. And I think particularly in a situation or market that we've been in currently, the stock side has gone up. It's been wonderful, but a lot of clients may be finding, "Wow, I really am—my stocks are much heavier weighted than my bonds are now."
Amy Chain: My allocation is not quite what I set out for to date.
Mary Ryan: Not the way it was at the beginning, that's exactly right.
Amy Chain: Let's stay with this rebalancing topic for a second. We've got quite a few questions. Keiron from Kansas says, "What is the best way to rebalance a stock/bond portfolio; once a year, once a quarter, etc., or when the percentage difference between the stock and bond target holding is more than 5%, 10%, etc.?" So Keiron wants to know, when should I be thinking about this? What should be my trigger points?
Mary Ryan: That's great because I think that's another piece that we sort of get a little, you know, loose on it. It's okay, oh, well, we're only 3% or not even paying attention to the percentage of where I'm out of balance.
Generally it is very important to have a discipline to this and that you may want to look at it every six months and maybe quarterly and maybe annually. But let's say it's every six months that you look at that portfolio, and you try to take the emotion off the table, and I think that's what's so important because sometimes we look at it, and like now we may look at it, and say, "Oh, the stock market's doing so well. I don't really want to take the profit off the table. It's going up."
Take the emotion out and say, all right, it's at my six-month mark. This is what I'm going to do. And generally, if you wanted to look at it and say, when I'm more than 5% out of balance—and what I mean by that is, let's say that your original asset allocation was a 50% stock/50% bond allocation—and if because, for example, now the stock market's been going up and as opposed to 50%, maybe you're finding yourself 55%, 56%, 57%, and it's great, but all of a sudden, you're really out there on the stock side, and the markets correct at some point, so we want to make sure that we are doing that old adage of, "Let's sell high and buy low," and that's what we need to keep in mind.
Conversely, when the markets are going down, and you're the other way, that also can be very, very emotional of saying, "Well, golly, now I'm supposed to be 50/50, but I'm really 45%, 44% in stock, 43%." Same thing, though; you want to sell those bonds, buy the stocks, get yourself back to 50/50. Take the emotion off the table. So yes, that's a really important thing. Set a date, set a time; make sure you're rebalancing on a regular basis, and find that percentage—5% is generally a good benchmark, I think.
All investments are subject to risk, including the possible loss of the money you invest.
Vanguard Asset Management Services are provided by Vanguard National Trust Company, which is a federally chartered, limited-purpose trust company operated under the supervision of the Office of the Comptroller of the Currency.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved.
It's a good time to check your target allocation
You may think your portfolio has the proper mix of stocks, bonds, and cash, but market movement may have upended your target allocation. Mary Ryan of Vanguard Asset Management Services™ explains when, why, and how rebalancing your portfolio should be on your investment schedule.
Other excerpts from this webcast:
- Make wealth planning a part of your year-end portfolio review
- Understanding the 2013 tax law changes
- Don't forget to take your required minimum distribution
- All investing is subject to risk, including the possible loss of the money you invest.
- Vanguard Asset Management Services are provided by Vanguard National Trust Company, which is a federally chartered, limited-purpose trust company operated under the supervision of the Office of the Comptroller of the Currency.
- This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved.