A new year brings a clean slate in so many ways. It is the time for making personal resolutions, setting new professional goals, and charting a new course in the year ahead both individually and as a family. After the demands of the holiday hustle and bustle, it feels good to begin anew. The same logic extends to your investment portfolio. A fresh new year brings portfolio opportunities, and key among them is rebalancing.

Rebalancing simply means bringing your investment portfolio back to its target asset allocation. Your target asset allocation is the ideal mix of stocks and bonds in your investment accounts, based on your age, investment time horizon, cash needs, and personal appetite for or avoidance of risk, and it varies from person to person depending on your specific financial goals. (And if you don’t know what your target asset allocation is or should be, it’s time to connect with a Wealth Advisor to have this essential conversation.)

Why should I rebalance my portfolio?

As the market moves up and down over time, your portfolio will inevitably drift from its original investment mix. Such is the nature of investing in markets with daily liquidity. Rebalancing the portfolio regularly ensures the level of risk you are taking on remains consistent over time.

For example, let’s say an investor’s target asset allocation is 50% bonds and 50% stocks. Next, let’s say the stock market performs very well over the course of 12 months and increases by 16%. As a result, the investor’s portfolio would have drifted to 42% bonds and 58% stocks, since stocks went up. Now the investor may feel he is being too aggressive and is out of his comfort zone. The solution is to rebalance by selling 8% of the stocks and using the sale proceeds to buy bonds in order to get back to his comfort zone of 50% bonds and 50% stocks.

When should I rebalance my portfolio?

The right time to rebalance your portfolio always depends on your unique situation, but in many cases, the new year is an excellent choice. January brings a fresh start for income taxes and wipes the slate clean for capital gains purposes. And how is that beneficial? Here’s an example:

If you had a good portfolio year in 2019, as many investors in the stock market did, you may have thought about rebalancing toward the end of the year to lock in profits and get back to your targets. But if you already had significant capital gains in 2019 from selling stocks or divesting a business, rebalancing in December would only add to the capital gains tally and drive the taxes you owe in April 2020 higher. Not a great result.

On the flipside, waiting just a few days or weeks and doing the same rebalancing in January means that the capital gains tally starts fresh at zero, and it also delays the resulting tax due date until April 2021. In many cases, this is a superior outcome.

As always, you’ll want to consult with your tax advisor to ensure January rebalancing is beneficial in light of your individual circumstances and particular income tax situation.

Next steps:

  1. To learn more about investing, asset allocation, rebalancing, and more, connect with a Bankers Trust Wealth Advisor
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