3 Tips for Rebalancing Your Portfolio in the New Year

Many investors are sitting on unrealized losses following 2022’s dismal performance. Fortunately, you can ‘harvest’ these losses by realizing them in taxable accounts. Then, you can use the losses to offset any capital gains or up to $3,000 in ordinary income. And, if you can’t use them this year, you can roll them forward into future years.

When harvesting losses, the IRS’ Wash Sale Rule prevents you from repurchasing the same (or a substantially similar) security for 30 days. However, you can purchase an alternative security that maintains a broad asset allocation but has sufficiently different holdings. And you can consider any asset allocation changes in other accounts (e.g., IRAs).

For example, suppose you own a 5% allocation to the S&P 500 ETF (SPY) in a taxable account and want to realize a 20% loss. At the same time, your Roth IRA is overweight by 2.5% in U.S. equities. After realizing the loss, you might only decide to repurchase a 2.5% allocation to U.S. equities and use a broader U.S. equity ETF or a managed index fund.

Click here to learn more about the implications of tax-loss harvesting.

Selling securities in a taxable account often generates capital gains. As a result, many investors direct cash inflows—such as interest or dividends—to underweight assets to maintain a target asset allocation. While they might pay taxes on these cash flows, they don’t have to sell any large positions and trigger potentially more significant capital gains.

In addition to rebalancing with cash flows, investors should make any withdrawals by selling their most overweight assets. These efforts can help bring asset allocations back into line without having to sell assets to rebalance the portfolio separately. So again, you can reduce any potential capital gains taxes and still benefit from a rebalanced portfolio.

Finally, if you’re over 72 years old, consider taking required minimum distributions (RMDs) from your retirement accounts while rebalancing your portfolio. Then, you can reinvest your RMDs into underweight assets in your taxable accounts. That way, you can maintain your asset allocations without generating any capital gains.

Check out here to see how Secure Act 2 will likely affect your RMDs.

Many investors maintain asset allocations using the same set of funds. But, over time, new funds launch, and you may want to consider lower-cost or better-performing alternatives. In particular, many mutual fund portfolio managers have launched comparable actively-managed ETFs offering lower costs and more liquidity.

Some of the best core equity ETFs include:

 

Some of the best core bond ETFs include:

 

While expenses can significantly impact returns, investors should also look at each fund’s performance and other metrics, like volatility. Those considering actively-managed funds may also want to consider the fund’s track record over time and individual portfolio holdings to ensure that the portfolio fits within their overall asset allocation.

Asset allocations play a central role in the volatility and returns of any diversified portfolio. With the stock market experiencing unprecedented volatility in 2022, it has never been more important for investors to rebalance their portfolios. And, when doing so, they’d be wise to keep in mind these best practices to minimize costs and risks.

Don’t forget to explore our recently launched model portfolios here.