Rebalancing and Taxes

[kingmountain]

Curious to hear the Bogleheads community's thoughts on rebalancing in a taxable account. Do you rebalance only by adjusting how new money is invested or do you also sell gains even though that sale will create a taxable event? If you are selling gains what is your framework for making that decision (i.e X% deviation from desired AA relative to Y% tax bracket)?

[Lee_WSP]

It is best to not create taxable events, but if you must (the assets fall well outside of acceptable parameters), you minimize the impact by making sure they're LTCG.

In other words, don't sell unless you absolutely have to, but when you do, make sure you've owned the asset for more than a year.

[tenkuky]

Agree with Lee.
Plus: turn off automatic reinvestment of dividends and cap gains to avoid a headache with gain calculations depending on lots sold.
You can optimize your tax situation by using "specific ID" and selling those lots that are most advantageous to you.

[Stinky]

I agree with Lee_wsp.

Before I take any gains by rebalancing in a taxable account, I would do everything I could to rebalance in a traditional or Roth IRA account, where there are no taxes when assets are rebalanced.

[livesoft]

I don't have to use a taxable account to rebalance because I do all rebalancing in tax-deferred accounts.

HOWEVER, since we have tax-loss harvested back in 2009, we have plenty of carryover losses that are used to offset realized capital gains and do not actually have any net capital gains when we sell from our taxable account in order to pay expenses. Please don't forget that return of capital is not taxed.

Those losses in 2009 are the losses that keep on giving and giving and giving and ....

[grabiner]

My own Investment Policy Statement says that I will only rebalance for a capital gain if I am outside of a tolerance band (a major asset class is off by 25% of its own allocation, or any asset class or subclass is off by 5% of my total portfolio) and I cannot fix this easily with current inflows. This has never happened in my 23 years of investing, although it came close in 2007; one more year of growth in emerging markets would have forced me to sell some of my Emerging Markets Index.

In contrast, when I do my annual rebalance, I rebalance to my target allocation if I can do it within tax-deferred accounts. I have not yet done my January 2020 rebalance, but when I do, I will sell stocks to buy bonds in my retirement plan so that my net bond allocation matches my 12% target. (I know it will be a sell, both because the stock market is up and because I increase my target bond allocation by 2% per year.)

[Randtor]

In contrast, when I do my annual rebalance, I rebalance to my target allocation if I can do it within tax-deferred accounts. I have not yet done my January 2020 rebalance, but when I do, I will sell stocks to buy bonds in my retirement plan so that my net bond allocation matches my 12% target. (I know it will be a sell, both because the stock market is up and because I increase my target bond allocation by 2% per year.)

Does this mean you have an Asset Allocation of 88% stock/12% Bond? Just curious as I am new to this (about a year now), trying to determine my AA and I am interested in what others are doing in that regard.Currently I am 55/45, age 68 (69 in March), and will be retiring in April.
Thanks

[iceport]

My own Investment Policy Statement says that I will only rebalance for a capital gain if I am outside of a tolerance band (a major asset class is off by 25% of its own allocation, or any asset class or subclass is off by 5% of my total portfolio) and I cannot fix this easily with current inflows. This has never happened in my 23 years of investing, although it came close in 2007; one more year of growth in emerging markets would have forced me to sell some of my Emerging Markets Index.

In contrast, when I do my annual rebalance, I rebalance to my target allocation if I can do it within tax-deferred accounts. I have not yet done my January 2020 rebalance, but when I do, I will sell stocks to buy bonds in my retirement plan so that my net bond allocation matches my 12% target. (I know it will be a sell, both because the stock market is up and because I increase my target bond allocation by 2% per year.)

My approach is similar to grabiner's, though it's not as explicitly defined. For the past 10 years or so, since the finalization of my asset allocation and asset location, I simply decided to try out this rule:

Never sell assets with taxable gains for the sole purpose of re-balancing.

Like grabiner, I've never exceeded my re-balancing bands, which I set at +/-20% of target value. Turning off automatic dividend reinvestment for all taxable holdings helps. My portfolio is nearly 44% taxable, so the tax ramifications for re-balancing is not a trivial concern.

The only downside to implementing the "no sell rule" is that it complicates re-balancing. My spreadsheet tells me precisely how far from the target allocations each of my asset classes is, but I can't blindly buy and sell according to those numbers. Instead, I use a supplemental re-balancing worksheet that I play around with for maybe 10 minutes and, through a bit of trial and error, find a reasonable way to move towards the targets without selling any appreciated taxable assets. Typically, this has meant leaving the overall equity allocation 1%-2% higher than the target, and the sub-class allocation proportions remarkably close to targets. Close enough. No unnecessary taxes.

[grabiner]

In contrast, when I do my annual rebalance, I rebalance to my target allocation if I can do it within tax-deferred accounts. I have not yet done my January 2020 rebalance, but when I do, I will sell stocks to buy bonds in my retirement plan so that my net bond allocation matches my 12% target. (I know it will be a sell, both because the stock market is up and because I increase my target bond allocation by 2% per year.)

Does this mean you have an Asset Allocation of 88% stock/12% Bond? Just curious as I am new to this (about a year now), trying to determine my AA and I am interested in what others are doing in that regard.Currently I am 55/45, age 68 (69 in March), and will be retiring in April.
Thanks

Yes, this is my asset allocation. It was 100% stock six years ago (age 46), and I am increasing my bonds by 2% per year.

It is a net allocation because I count my mortgage as a negative bond. If I decide to pay off my mortgage early (not worth it now because I have a low rate and can still deduct the interest), I will pay it off with bonds, so that I keep the same stock-market exposure and the same risk level. Not counting the mortgage, I am currently 82% stock because my mortgage is a small part of my portfolio.

[Randtor]

Yes, this is my asset allocation. It was 100% stock six years ago (age 46), and I am increasing my bonds by 2% per year.

It is a net allocation because I count my mortgage as a negative bond. If I decide to pay off my mortgage early (not worth it now because I have a low rate and can still deduct the interest), I will pay it off with bonds, so that I keep the same stock-market exposure and the same risk level. Not counting the mortgage, I am currently 82% stock because my mortgage is a small part of my portfolio.

OK, I thought perhaps I had read it wrong. Got it now. I am still trying to figure out my AA according to my tolerance level, but that changes with the market! When up, I am sure I can tolerate more. When it drops, I kick myself for losing (on paper) money. There doesn't seem to be a middle ground for me! I know I should be 30/70 according to the "Age -" formula, but that seems too conservative for me. I think i will likely end up 40/60 when I actually fully retire. Thanks!

[JustinR]

Curious to hear the Bogleheads community's thoughts on rebalancing in a taxable account. Do you rebalance only by adjusting how new money is invested or do you also sell gains even though that sale will create a taxable event? If you are selling gains what is your framework for making that decision (i.e X% deviation from desired AA relative to Y% tax bracket)?

Use new money if you can.

Don't automatically reinvest dividends from your taxable accounts. Rebalance using them.

Rebalance in your retirement accounts if you can.

Sell things in your taxable as a last resort.

[beehivehave]

Curious to hear the Bogleheads community's thoughts on rebalancing in a taxable account. Do you rebalance only by adjusting how new money is invested or do you also sell gains even though that sale will create a taxable event? If you are selling gains what is your framework for making that decision (i.e X% deviation from desired AA relative to Y% tax bracket)?

Use new money if you can.

Rebalance in your retirement accounts if you can.

Sell things in your taxable as a last resort.

Good. Add "Use distributions if you can".
Not a problem for most who track AA monthly and make appropriate adjustments in a timely manner.

[lairdb]

So... maybe the answer is "you planned poorly", but what is the group advice when your target AA changes more rapidly, e.g. due to life circumstances changing (job, spouse job, baby, pandemic, natural disaster, etc.)?

Perhaps you were 80/15/5 and planned to move slowly to 60/35/5 over the course of 15 years via all new contributions going to Total Bond -- but now your risk tolerance has changed faster than expected, and you'd like to shift in 3 years, not 15.

(Not actually my personal situation, but for the purposes of discussion...)

[JustinR]

Curious to hear the Bogleheads community's thoughts on rebalancing in a taxable account. Do you rebalance only by adjusting how new money is invested or do you also sell gains even though that sale will create a taxable event? If you are selling gains what is your framework for making that decision (i.e X% deviation from desired AA relative to Y% tax bracket)?

Rebalance using a combination of:
1) Your retirement accounts
2) New money

Don't sell in your taxable accounts other than for tax loss harvesting.