Dear Liz: Is there a tax aspect to rebalancing your portfolio? You’ve mentioned the importance of rebalancing regularly to reduce risk.
Answer: Rebalancing is basically the process of adjusting your portfolio back to a target asset allocation, or mix of stocks, bonds and cash. When stocks have been climbing, you can wind up with too high an exposure to the stock market, which means any downturn can hurt you disproportionately.
There definitely can be tax consequences to rebalancing, depending on whether the money is invested in retirement plans.
Rebalancing inside an IRA, 401(k) or other tax-deferred account won’t trigger a tax bill. Rebalancing in a regular account could. Investments held longer than a year may qualify for lower capital gains tax rates, but those held less than a year are typically taxed at regular income tax rates when they’re sold.
Tax experts often recommend selling some losers to offset winners’ gains, and “robo advisor” services that invest according to computer algorithms may offer automated “tax loss harvesting” to reduce tax bills.