Blogs & Comment

8 tips for reducing rebalancing costs

Rebalancing involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation, says Rebalancing is recommended because market trends can change your asset mix and make it too aggressive or conservative for your risk tolerance, age, and time horizon.
But buying and selling securities to rebalance a portfolio incurs costs, notably broker commissions and capital-gains taxes. Here are some ways to cut those costs:
1. Avoid selling overweight assets and instead add new funds to the underweight assets to bring portfolio proportions back in line. Redirect dividends and interest payments into the underweight holdings.
2. In taxable accounts, offset capital-gains taxes arising from sales of overweight holdings with tax-loss sales. Carry forward tax losses accumulated from the three prior years. Or sell underwater holdings from the same asset class or from other classes as long as they are replaced with similar investments.
3. Rebalance first in registered accounts to avoid capital-gains tax. But if an unregistered account has securities with losses, it may be the place to rebalance.
4. If retired, consider using withdrawals from capital to rebalance. Take money needed for living expenses just from the better performing assets.
5. Consider rebalancing less frequently every two to four years instead of annually. Not only does this reduce commissions and taxes, but studies show it tends to increase investment returns. The trade-off, of course, is increased volatility.
6. Dont rebalance unless an asset moves outside a threshold band (say five percentage points on either side of the target allocation); to minimize capital gains, just sell down to the band or somewhere inside, not to the exact target.
7. Select investment vehicles with rebalancing in mind. For example: i) avoid thinly traded securities (wide spread between bid and ask prices is a cost) and ii) consider a portfolio made up of 3 or 4 broadly based exchange-traded funds instead of one made up of 10 or more securities (more trades required to rebalance).
8. Rebalancing in January postpones paying capital-gains taxes for about 14 months.