Should I Stop Rebalancing?

[John151]

I'm a conservative retiree in my sixties. Several years ago, I decided to allocate 30% of my financial assets to stocks, with a 5% band on either side. Most of my stocks have been in taxable accounts, with a smaller amount in accounts that are tax-advantaged. As stocks have risen, I've rebalanced by shifting from stocks to bonds within my tax-advantaged accounts, where exchanges can be made without triggering taxes. But as the stock market has risen even further, I've reached the point where I have no more stocks to exchange out of within my tax-advantaged accounts. All of my stocks are now in taxable accounts, and I'm bumping up against the 35% maximum allocation.

I've refrained from investing more in stocks than I have already. My stock dividends are deposited into my money market account, and any "new" money goes into a tax-exempt bond fund. So I don't think I can rebalance out of stocks without selling shares and triggering thousands of dollars in capital gains taxes. Should I bite the tax bullet and rebalance? Or should I let my stock allocation continue to drift upward?

Perhaps I should add that my pension and my stock dividends are enough to cover my expenses, and I'd still have enough to live on even if stocks dropped dramatically. Also, I'm single and have no children to provide for.

[cheese_breath]

First, what tax bracket are you in? If you're in the 10% or 15% brackets and sell, your long term capital gains would be taxed at 0%.

Rebalance or let the stock drift upward? What if it drifts downward instead? For sake of argument lets say you're in the 35% bracket. And let's say you're $50,000 above your band. Would it be better to sell $50,000 and have $32,500 left after taxes, or risk the stock drifting downward instead of upward and have nothing left of the $50,000 left? Since you don't need the money anyway I don't know which answer is right for you.

[BrandonBogle]

But as the stock market has risen even further, I've reached the point where I have no more stocks to exchange out of within my tax-advantaged accounts. All of my stocks are now in taxable accounts, and I'm bumping up against the 35% maximum allocation.

I've refrained from investing more in stocks than I have already. My stock dividends are deposited into my money market account, and any "new" money goes into a tax-exempt bond fund. So I don't think I can rebalance out of stocks without selling shares and triggering thousands of dollars in capital gains taxes. Should I bite the tax bullet and rebalance? Or should I let my stock allocation continue to drift upward?

First, what tax bracket are you in? If you're in the 10% or 15% brackets and sell, your long term capital gains would be taxed at 0%.

This. In addition, check your individual lots to see if you have specific lots with minimal gains.

[Dale_G]

John, I am approaching a similar situation. My taxable account is essentially all equities and my tax deferred/tax free accounts are 95% invested in bonds. As RMDs continue, the tax deferred space will become more limited - and there will be no room for equities there at all.

I reinvest the RMDs (and taxable dividends) in both munis and equities in the taxable account, but the deferred accounts will soon be all bonds - and therefor there will be no opportunity to rebalance out of equities there.

I do have some tax-loss carry-forward that would allow rebalancing in the taxable account, but that could run out, if the market continues its march upward.

If and it is always a big if, the market continues to run north, I have decided to allow my equity allocation to also run north.

My situation is different in that I have adult children who may benefit from this decision.

Dale

[FNK]

There's also the option to donate appreciated shares to charity.

[gerntz]

"Truman Clark, of DFA, examined rebalancing in detail in three papers published online on the DFA site in Fall of 2001. He concluded that, "the proposition that a rebalancing strategy can increase expected return is dubious," "


http://www.evansonasset.com/index.cfm?Page=3

[roymeo]

"Truman Clark, of DFA, examined rebalancing in detail in three papers published online on the DFA site in Fall of 2001. He concluded that, "the proposition that a rebalancing strategy can increase expected return is dubious," "


http://www.evansonasset.com/index.cfm?Page=3

OH NO! I rebalance by putting my new money generally into classes that are low. I'll have to stop adding money!

roymeo

[livesoft]

But, but ... ! We have learned on this forum that folks do not rebalance to increase expected return. Instead they rebalance to control risk.

[Peter Foley]

Based on your comments, you have no need (or little need) to take risk. We have had quite a nice run in the market over the past couple years. I don't see any problem with taking some money off the table (selling some equity positions) especially if you can remain in the 15% bracket. If you do have a charity that you favor, you could also arrange to have them take some shares of a taxable equity fund in lieu of future donations.

Now in early 2009 I was asking myself this question as the market was in relative freefall. At least these are happier times.

[John151]

I'm grateful to all of you for your help and advice. Thanks to you, I'll be able to make a much more informed decision.

[Dandy]

It is really up to you. You don't need the money from the portfolio and have no need to leave it to anyone. You have a relatively low allocation to equities so you can choose to have your equity allocation grow and avoid taxes or take some tax now to keep to your target and conservative preference. Which is more important to you - lower equity allocation or avoiding taxes?

[dbr]

Change your rebalancing band to 10% and let the problem go away for awhile

Including the rest of the advice you can also consider rebalancing back only to the band edge, making minimal sales. I would also look a few years out and see what your tax picture is going to be in the future. If you do end up paying CG taxes is this year the best year to do it compared to later, or vice-versa. It is never a good idea to volunteer to pay taxes if you have an estimate you can pay less later.

[retiredjg]

I think it depends on how you feel about being higher than 35% stocks. If it makes you uncomfortable, sell some stocks and pay the tax - rather than let the tax tail wag the dog. Your comfort is more important than your taxes. If possible, sell up to the top of the 15% bracket each year (zero capital gains rates for long term gains) and put that into taxable and/or muni bonds or CDs. or I Bonds.

If it does not make you uncomfortable and you'd rather not pay taxes, let the stock percentage rise. Yes, your money will be at higher risk, but it sounds like that would not put you or your welfare at any more risk.

In the next crash, you can rearrange things in a little different way. Perhaps reduce your stock percentage, but increase the size of the band. Or put things into a balanced fund or target fund that maintains a constant stock to bond ratio.

[YDNAL]

I'm a conservative retiree in my sixties....

Perhaps I should add that my pension and my stock dividends are enough to cover my expenses, and I'd still have enough to live on even if stocks dropped dramatically. Also, I'm single and have no children to provide for.

John,

Other than perhaps Inflation, there is NO apparent need to take risk. What are your savings for?