What to know before doing any year-end portfolio rebalancing

  • After a year of double-digit stock market returns, it may be time to rebalance your portfolio, shifting back to target allocations. 
  • Before realigning assets, investors may consider their risk tolerance, goals and tax consequences, experts say.
  • However, some advisors prefer ongoing adjustments, making changes to investments based on “triggers” throughout the year.

After a year of double-digit stock market returns, it may be time to rebalance your portfolio, shifting the percentage of stocks, bonds and other assets back to target allocations. 

Investors choose each amount based on their risk tolerance and long-term goals. However, as markets fluctuate, weightings may drift from their original preferences. 

If a portfolio becomes too heavy in stocks, for example, it may expose someone to added risk during periods of volatility, with the possibility of bigger future losses.

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On the flip side, a portfolio overly weighted in bonds may make it harder to achieve the returns needed to reach long-term goals.

But there are some things to consider before buying and selling assets to realign, experts say.

Here's what investors need to know.

"Before completing a year-end portfolio rebalance, review your financial plan and risk tolerance to help determine your target asset allocation," suggested certified financial planner Jon Ulin, managing principal of Ulin & Co. Wealth Management in Boca Raton, Florida.

Life events like a birthday milestone, getting married, having children or entering retirement may spark a change in risk tolerance and investing goals for the new year, he said. 

Investors also need to measure how much their portfolio allocations have drifted since their last review.

For example, a portfolio of 60% stocks and 40% bonds may have shifted to 70% stocks and 30% bonds based on market performance, Ulin said. 

While rebalancing involves buying and selling, it's still part of a disciplined, long-term strategy, rather than "speculating with large wagers" on individual stocks, cryptocurrency and high-risk sectors, he said.

Consider the tax bite

Investors may also consider the tax impact, particularly when selling appreciated assets from a taxable portfolio.

While assets held for more than one year qualify for lower long-term capital gains rates, investments owned for less time may incur regular taxes, known as short-term gains.

"If you are facing a short-term gain from selling a position, looking at when that gain becomes long-term is a good idea," said Philip Rutterer, a CFP and owner of Rutterer Planning in Nashville, Tennessee.

For example, if there are only a few days or weeks until an asset passes the one-year mark, it may be better to pause on the sale, he said.

Another lesser-known tactic allows investors below certain income thresholds to sell a profitable asset, pay no long-term capital gains and rebuy it for a so-called "stepped-up basis," bumping the purchase price to the current value for lower taxes in the future.

Rebalance throughout the year 

Although year-end may be a chance to realign portfolio assets, many advisors opt for an ongoing rebalancing strategy. 

"We don't subscribe to a once-per-year rebalance theory," said Benjamin Offit, a Columbia, Maryland-based CFP and principal at Offit Advisors, explaining how specific "triggers" may prompt changes throughout the year. 

For example, if a client's target allocation is 10% small-cap stocks, and those assets grow to 12% or drop to 8% of the portfolio, it may be time for adjustments, he said.

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