Since the market bottom in 2009, we have seen significant growth in the major stock market indexes. Last year was particularly good, and many investments are trading at record highs.
Emotions tell us to hang on to the winners and sell our losers. However, we must remember to do the rational thing and follow the age-old motto of “buy low and sell high.” With that being said, now that the major market indexes seem to be trending sideways, this would be a good time to review your portfolios and consider rebalancing or repositioning your investments to trim gains, and possibly add to your investments that are down.
This advice works particularly well in retirement accounts such as IRA’s and 401k’s. They are exempt from the capital gains that arise from selling high after buying low. We must keep the money in the account but can rebalance without any current taxation. This strategy is particularly important for those close to retirement. Now that their focus needs to change from accumulation to distribution, it may make sense to sell out or at least trim the more aggressive positions that have run up over the last few years and reinvest into more income-oriented investments.
For taxable accounts, this strategy can be a little trickier and will require some careful planning if one is going to avoid any unwanted tax liability. A hypothetical example is as follows:
Let’s say I had a client called Chuck, and Chuck had recently switched from a full-time salaried job to a part-time, commission- based job. He is uncertain about his cash flow going into semi-retirement. He knows that he needs $5,000 a month to live but is not confident that he can immediately generate that income from his new job. Since he is over 59.5 years old, he asked me for a recommendation to start drawing from his large IRA. After reviewing his overall portfolio, I would recommend a different strategy. In addition to the large IRA he and his wife have a sizable trust account with a couple of investments that had outpaced the rest of the portfolio over the last few years.
After doing some research and calculations, I let him know that by trimming his largest position, we could raise the needed cash and for expenses and pay taxes at the lower 15 percent rate, as opposed to 25 percent if we took from the IRA. In addition, by trimming the highly appreciated stock, we were realizing the gain and locking it in. Should we have a correction, our exposure to a large loss is reduced since we sold some of the shares at the market highs.
Chuck still owns significant shares and will still benefit should the stock move higher.
Lastly, since we did the gain/loss analysis before the year’s end, we could estimate his additional tax liability and therefore be prepared to avoid those dreaded April 15 surprises. Although not thrilled about paying the tax, he now had the money ready to cover both his taxes and his monthly expenses and could concentrate on building up his real estate business.
Information is provided as a courtesy and is not intended as investment advice. Please consult with your financial or tax professional before taking any action. Indices are unmanaged and do not allow for direct investment. Past performance cannot guarantee future results. Rebalancing cannot ensure profit or a prevention of loss. NPC does not provide tax or legal advice.
Frederick Fisher is a CFP®, and Insurance Agent. Securities and advisory services offered through National Planning Corporation (NPC), Member FINRA/SIPC, a Registered Investment Adviser. Ostrofe Financial and NPC are separate and unrelated companies. For questions or suggestions, contact Rick Fisher at 530-273-4425, or firstname.lastname@example.org. Branch address: 565 Brunswick Road, Ste. 15, Grass Valley, CA 95945.