Basic question re portfolio reallocation

[Scuba]

DH & I have a taxable portfolio consisting of mostly equities, a combination of individual stocks and ETF's/MF's. We have decided we'd like to reallocate some of this to fixed income/cash so that we have some "dry powder" to take advantage of future significant market dips, as well as a bit more downside protection than we have now.

I'm trying to decide what to sell to free up the "dry powder" in our taxable portfolio. If I sell what has appreciated most, I'm "locking in gains" but would have a sizable tax bill to show for it. I could also sell specific securities and lots such that the tax impact is negligible, but that means I'd be selling low and realizing losses on some of our investments. I can generate the cash I want either way, but it seems to me that generating cash with the least tax consequence would be smart. However, that strategy doesn't necessarily line up with the "buy low, sell high" philosophy.

We've always been more buy & hold investors so I don't have much experience with this. Comments/input please?

 

[RobbieB]

I'd sell high and lock in the gains. If long term you get lower taxes.

 

[Scratchy]

We have decided we'd like to reallocate some of this to fixed income/cash so that we have some "dry powder" to take advantage of future significant market dips,

I think you should decide what your fixed income allocation should be based on your risk tolerance, not based on the idea you are going to jump back into equities when you think you recognize a market dip. Any plan to change your allocation based on how you think the market is doing is market timing and on average does not end well.

 

[Sunset]

You can have your cake and eat it too:

If you have stock X and it has really gone up and there are multiple lots of it, then sell whichever lots give you the lowest tax impact.

It is also the time to look at the laggards, example: if you have a stock that in the past number of years while everything has gone up X%, this stock has only risen by 1/3 or 1/2 as much, why would you think when times are bad that it is suddenly going to do greater.

 

[donheff]

I struggled with the same issue when I recently liquidated some equities to come up with a down payment for my daughter's house. I was tempted to sell some VG Total Stock which was the most appreciated but I ultimately sold Total International with a much lower capital gain. It is really impossible to judge the long term consequences and that is the point. I was comfortable dropping my International portion a bit so why not go that way and avoid the extra tax. I face a mini version of this dilemma when I periodically withdraw to fund expenses beyond what is covered by dividends from the taxable account.

 

[pb4uski]

Well, first.... it sounds like you are market timing rather than rebalancing... and market timing is a fool's errand... especially if you end up having to pay taxes for the pleasure.

Second, if you can manage you income, including LTCG, to be below the 0% threshold then there would be no capital gains tax.

Other than that, you could sell the losers and capture the losses, then sell some gainers to utiize the losses to raise cash at no tax cost.

My taxable portfolio is all equity mutual funds (other than my cash allocation) and almost all have 20% to 50% unrealized gains so I'm resigned to leave them alone and make my moves elsewhere in my portfolio. You could do the same and sell equities to raise cash in your tax-deferred or tax-free accounts if you really want to market time.

 

[jIMOh]

I would start with big picture before dealing with details of what to buy and sell...

how old are you, and how long to retirement?
What is % of portfolio in IRA/401k vs taxable accounts?
What holdings are in tax advantaged accounts (Roth-deductable IRA-401k-other)?

fundamentals- probably best if the highest growth assets are in Roth-
My Roth is 95% equities, my 401k is closer to 50-50 stocks/bonds

timing market is bad
using asset allocation is good

Design a desired asset allocation for whole portfolio
examples might be 80% stocks and 20% bonds or 60% stocks and 40% bonds
if you don't know this, read about the efficient frontier, asset allocation or other related topics.

Once you answer above, and you know the whole desired asset allocation of whole portfolio, then start looking at what to buy and sell.

 

[Scuba]

Thanks for the responses so far. I'm 58, already retired for 2.5 years. Roughly 37% of portfolio is in IRA's and other tax-deferred vehicles (deferred comp plans). This is invested in mostly hard money loans/trust deeds, along with some bonds, a balanced fund and a stable value interest bearing account. DH just turned 60 so he can access his IRA if needed but we don't intend to do that anytime soon. We also have a defined benefit pension we haven't started yet (enough to cover mortgage and HOA, but that's about it) and SS for both of us that will be tapped into in the future. All IRA's are traditional IRA's as we never qualified for Roths while working and our income has been too high since retiring for it to make sense to convert.

The other 63% of our portfolio is in a combination of cash/money market (4%) and equities (96%). So overall we are about 60% equities, 28% trust deeds and other real estate investments, and 12% bonds and cash/money market.

Our asset allocation has been based on having the next 2-3 years of cash requirements in cash/money market accounts or short-term bonds, with the rest invested more aggressively. So far that has served us very well, but I recognize that we've been fortunate with market performance since retiring. We just invested a chunk of our cash in a medical building real estate project. Hopefully it will be a profitable investment, but most of the returns will come later rather than the next few years. Therefore, in order to get back to our previous asset allocation and have cash needed to fund our lifestyle while avoiding selling equities in a down market should one occur, we need to sell some equities. I was also thinking that since equities have had such a good run for a long time, perhaps it is a good time to change our asset allocation to be more conservative.

Call it market timing, but I see nothing wrong with getting more conservative when there's been a good run, and if equities go "on sale" in the future, tilting our asset allocation to be further towards equities again. I am comfortable being between 50-75% equities overall and expect to fluctuate within that range. During the 2008-2009 downturn, we were fully invested in equities. We didn't sell so our value eventually recovered, but we had no cash to take advantage of things being on sale. I'd like to learn from that and be ready next time.

Anyway, that's our situation. I can easily choose specific lots of equities to sell such that tax consequences are negligible and I raise the cash I want. However that means locking in losses to avoid taxes. Most losses would be on international ETF's. Alternatively I could sell stocks/ETF's that are at or near 52-week highs, lock in gains, and pay some taxes. Just wondered what this group thought was the better strategy.

By the way, we cannot manage our income down to pay zero capital gains taxes. Too many dividends and too much interest, plus some taxable deferred comp distributions.

 

[donheff]

With 37% of your $ in IRAs why not sell equities there? No tax consequences. Keep equities in the taxable.

 

[LOL!]

I'd sell ALL the losing positions now. That's called "Tax-loss Harvesting", then you can buy similar, but not substantially identical equities to replace them meaning you are not selling low at all. Then you can use the harvested losses to offset gains from selling the things with the least gains that you don't want to own anymore. Then use that money to buy bond funds.

I just posted in LOL!'s Market Timing newsletter how I raised cash without worry and without taxes despite selling total stock market index shares in a taxable account.

 

[RunningBum]

I would also do tax loss harvesting. Beyond that, don't let the tax tail wag the dog. Sell the stocks you wouldn't buy now, regardless of whether they have gained a lot in the past or not. You must've put some thought into stock selection when you bought, go through the same process now. Your goal is to maximize your portfolio, not minimize taxes. If you are deciding which lot of shares of a mutual fund or individual stock, you can optimize for taxes, but trying to decide whether to sell stock/fund A vs stock/fund B should not be based on taxes. Another way to think of it is to decide what your ideal portfolio would be now, then execute to make that happen.

 

[audreyh1]

Well, first.... it sounds like you are market timing rather than rebalancing... and market timing is a fool's errand... especially if you end up having to pay taxes for the pleasure.

The OP didn’t say they were rebalancing. Reallocation was the word - changing allocation and trying to minimize taxes. Definitely going to more cash to wait for market dips/buying opportunities is market timing.

 

[Scuba]

With 37% of your $ in IRAs why not sell equities there? No tax consequences. Keep equities in the taxable.

Zero equities in IRA’s. All in taxable accounts.

 

[Scuba]

The OP didn’t say they were rebalancing. Reallocation was the word - changing allocation and trying to minimize taxes. Definitely going to more cash to wait for market dips/buying opportunities is market timing.

A bit yes, but mostly need to replenish cash because we just invested most of it in real estate.

 

[Scuba]

I'd sell ALL the losing positions now. That's called "Tax-loss Harvesting", then you can buy similar, but not substantially identical equities to replace them meaning you are not selling low at all. Then you can use the harvested losses to offset gains from selling the things with the least gains that you don't want to own anymore. Then use that money to buy bond funds.

I just posted in LOL!'s Market Timing newsletter how I raised cash without worry and without taxes despite selling total stock market index shares in a taxable account.

Got it, makes sense to me. Thanks.

 

[Scuba]

I would also do tax loss harvesting. Beyond that, don't let the tax tail wag the dog. Sell the stocks you wouldn't buy now, regardless of whether they have gained a lot in the past or not. You must've put some thought into stock selection when you bought, go through the same process now. Your goal is to maximize your portfolio, not minimize taxes. If you are deciding which lot of shares of a mutual fund or individual stock, you can optimize for taxes, but trying to decide whether to sell stock/fund A vs stock/fund B should not be based on taxes. Another way to think of it is to decide what your ideal portfolio would be now, then execute to make that happen.

I agree, makes sense. Thanks.

 

[audreyh1]

A bit yes, but mostly need to replenish cash because we just invested most of it in real estate.

What you are describing does not sound like rebalancing. Rebalancing is not going to a higher level of cash/fixed income waiting for buying opportunities later.

Now if you have more equities than target allocation, and less fixed income/cash than target, then rebalancing make sense regardless of what market opportunities might lie around the corner.

 

[Scuba]

What you are describing does not sound like rebalancing. Rebalancing is not going to a higher level of cash/fixed income waiting for buying opportunities later.

Now if you have more equities than target allocation, and less fixed income/cash than target, then rebalancing make sense regardless of what market opportunities might lie around the corner.

It’s a combination of rebalancing and tweaking AA. We need to replenish our operating cash because we invested a chunk of it in a real estate venture, so that part is rebalancing. However I am also considering moving to a slightly more conservative AA ... 50% rather than 60% equities. May not stay there forever. I’m a fan of buying things on sale, whether that be stocks or consumer goods.

 

[pb4uski]

I would harvest all losses and then harvest lowest gains until losses have been utilized and see how much that raises. Then once the wash sale period has expired, rebalance as desired within tax-deferred accounts if possible.

 

[Scuba]

Thanks to all who responded. Decided to sell large chunk of international ETF and use loss generated to offset gains by selling a few individual stocks I no longer wanted to hold. Allocated part of proceeds to Fido’s money market fund paying 2.3% and part to a muni fund. May sell additional stocks later in the year as I still have a smallish loss to use.

 

[DrRoy]

I would try to minimize taxes. Also, selling a poor performing investment is not bad either.