Since we are currently experiencing the second longest bull market in history, some investors are worried we are nearing the end of our hot streak and therefore should move out of stocks. I don’t recommend moving out of stocks, but I do recommend a portfolio pit stop, which is a fun way of saying stopping to reassess your current allocation. In this pit stop you can make sure that your current allocation continues to suit your risk tolerance and long-term investment goals since markets have moved up significantly.
It might seem like a review might not be necessary, seeing how neglect has actually benefited portfolios in the recent past. The problem with this is the bull market makes everyone look like their strategy is the right one. You want to make sure your allocation is right in “good times” and also right when we experience a correction.
Not rebalancing your current allocation can make a significant impact on your portfolio over time. For example, let’s say you started your portfolio five years ago with 40% U.S. stocks, 20% international equities, and 40% in core bonds, and haven’t touched it since. Since then, U.S. equities are gaining more than expected, foreign investments are lagging, and bonds are having modest returns, so your portfolio would have shifted from 40-20-40 to 52-19-29 allocation. It might not seem like a huge shift, but you now have a 70% stock and 30% bond portfolio, rather than the more conservative 60/40 you had set up. You are also five years older now and closer to retirement, so that might not be the right allocation according to your risk tolerance.
The allocation between stocks and bonds is not the only allocation that shifts. Really any allocation between assets with differing returns will shift over time. In my opinion, now is the time to take some of the profits from your U.S. holdings and add to your less expensive international stocks. As mentioned earlier, foreign stocks have lagged over the past several years, which is why I believe that now is a good time to consider increasing the weighting of foreign stocks in your portfolio. Having international stocks does not always reduce your risk, but it’s still helpful because global markets tend to move with the stock sectors that dominate their economies. Also, 70% of the stocks trade outside the U.S., so you don’t want to limit your opportunity.
Unfortunately, rebalancing can come with tax consequences depending on the type of account. If you’re rebalancing inside of a tax-sheltered 401(k) or IRA, there’s no tax consequences to hassle with. If you’re selling shares in a regular, taxable account, things can get a little trickier. If the investment has been owned for at least a year, you have to pay the long-term capital gains tax typically of about 15%. However, it is possible to get around the tax bill by donating appreciated shares of stock to a charity. When you donate an appreciated asset to charity, you owe no capital gains tax and also get to claim the donation as a charitable contribution on your itemized tax return.
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