In writing about the lies that financial advisors sometimes tell, the subject of rebalancing your portfolio came up. Obviously, rebalancing your investments to track your desired asset allocation is an important thing to do. When thinking about how often (and how) to do it, though, you need to keep costs in mind.
On the one hand, you need to consider transaction costs. If you’re just holding a bunch of no load mutual funds, you’re in the clear, but… If your portfolio includes individual stocks, ETFs, and the like, then you’ll need to be cognizant of the costs — unless, of course, you’re getting free trades from someone like Zecco.
Another concern is taxes. If you’ve decided to rebalance your retirement portfolio, then this is a non-issue. But if you’re re-balancing investments in a taxable account, selling shares that have appreciated will create a capital gain, thereby exposing you to taxes. Thus, you’ll need to think very carefully about whether or not getting your holdings back in line is worth the tax hit.
Perhaps the easiest workaround for avoiding taxes when rebalancing is to simply adjust your contributions such that you’re buying more of the lagging portion of your portfolio going forward, as opposed to selling your winners to buy the laggards. While this is a less immediate method of rebalancing, it’s equally effective, and totally pain free when it comes to taxes.