Stocks have had an amazing recovery since “The Great Recession.” New market highs have been a deserved reward for investors who endured the preceding decline, yet stuck to their plan. And just as it was prudent to “buy low” during the downturn, it is equally wise to “sell high” as the market rises.
Rebalancing when an asset strays too far, in either direction, from its target allocation percentage serves an essential purpose—managing risk. It is also a proven discipline which adheres to the investment ideal of “buy low, sell high.”
Trimming an investment which has become “overgrown” generally means realizing gains and paying taxes. Up until recently, however, many investors have been sheltered by losses realized in 2008 and 2009 (in portfolios and within funds). Those prior-year losses have often offset gains from rebalancing, raising cash, and fund distributions—leaving little, if any, tax exposure the past few years.
If past losses have been mostly used up, investors should expect higher capital gains taxes going forward. This is neither new nor unexpected. It is simply part of being a successful, long-term investor.
It is worth noting a tax liability is embedded within all portfolios which experience growth. Investors can only influence when the liability is realized and taxes become due. We can think of no better time or reason than rebalancing.
To minimize tax exposure at all other times, investors should trade infrequently, hold REITs and bonds in IRAs whenever possible, strategically harvest losses, and choose tax-friendly funds.