The Tax Advantages of Portfolio Rebalancing

March 7, 2023

Rebalancing your portfolio can lead to some tax advantages. In this highlight, Bo and Brian discuss some of the ways rebalancing can help from a tax standpoint.

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“We all know that one of the things that’s a certainty that none of us can avoid is the fact that we will experience taxation, especially if in this country. We know that we’re going to have to pay taxes. I think it was probably Benjamin Franklin who said there are only two things that are certain, death and taxes. So, if it is a certainty, if it’s something that we know that we’re going to deal with, we want to make sure that as we think about rebalancing, is there a way, is there a mechanism that we can do so that will help us from a tax standpoint?

Well, the cool thing about the Money Guy show is we love to give case studies. So, you know why tell people that this is powerful for rebalancing for tax purposes. It’s easier if you actually have an illustration to see how this works. And Bo, I loved Daniel did this. He was trying to throw a little bit towards your way, but two birds one stone, two birds one stone. So, think about this: let’s say that Tim is an investor and he has $200,000 in a taxable investment account. So, there’s going to be some natural tax drag associated with that. Let’s say that the target allocation in this account is 50% S&P 500, 50% International. So, this is an all-equity portfolio, or $100,000 invested in each of those, right?

Well, let’s assume that we go through a year like 2022, or maybe the market was not as strong, and the S&P 500 loses 20%, and the International fund loses 30%. So now, instead of having a $200,000 account, Tim is down to a $150,000 account. And instead of him being 50-50 allocated, he has 47% in his International Holdings and 53% in his S&P 500. You would argue that he is out of balance and he likely needs to re-balance his portfolio. Anything you’d add to that?

Well, I think it’s interesting because we’re actually, we are without meaning to, we did this in Financial Mutant fashion. It’s because the easy way to rebalance this is to look at your U.S. stocks, your International, take them right back to the same allocation. But the problem is, if you just did it in that simple way, it would only generate about $1,500 of taxable losses that you’d be able to recoup. Now, if you combine this rebalancing strategy with tax loss harvesting, where you bought something that was similar but not the same so that it actually passes the IRS rules, you could actually use this opportunity of tax rebalancing to generate a huge tax savings. Yeah, that’s right. Instead of selling $5,000 of one holding and buying $5,000 of the other, you’re saying he could sell the entire account, he could sell all of both of them, buy into something demo, something similar but not identical, and he’s going to have a huge loss benefit that he’s going to be able to use both this year as well as many years into the future.

So remember, balancing can be a great thing that not only allows us to tie ourselves to our overall investment goals and objectives, but it can be something that we utilize especially in years like last year to help us save on taxes because it lets us pull in another financial tool like the tax loss harvesting.

For more information on rebalancing, check out the full episode called, “Watch This Before Rebalancing Your Investment Portfolio!”



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