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The Mechanics Of Rebalancing

July 14, 2022

We work with each client to develop an asset allocation in line with their goals and risk level. Let’s assume a basic 60% equity/stock sleeve and a 40% cash and bond sleeve. If the market rises, it is likely the 60% rises to possibly 65% while the cash and bonds may decline to 35%.

In order to bring the portfolio back in balance, we would sell 5% of the equity sleeve (remember it increased because of profit so we are selling higher than the investment started out) and take the proceeds and buy cash/bonds to bring the 35% up to 40% – buying low.

While an oversimplification, this is in essence how rebalancing works. If the portfolio is a retirement plan, then there are no tax consequences to the buys/sells. If it is a taxable account, consideration has to be given to the tax impact of taking some of the profits or whether it is better to sell less so the capital gains aren’t as high.

Another way to rebalance is to use new deposits and cash dividends and interest in order to buy what is underweight. Doing so may reduce or avoid taxable gains for what is overweight.

Are there tax losses in another holding that could offset the capital gains? This is part of the juggling act that is part of the rebalancing process. While some of it maybe science, another part is art. The two need to blend together.


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