Rebalancing Subcomponents: choose profit or minimal taxes?

[dualstow]

As much as I love Harry Browne's books, there is a lack of specific instructions for implementation. Maybe he was keeping it simple, or maybe these instructions would have shown up in later editions had Browne lived longer. I'm grateful for the forum for helping to fill in these gaps. I did a half-"chapped" search to see if this has been asked before, but didn't find much.

Two scenarios. In both of them, your long-term treasurys are going to pop at 35% of your holdings.
1) You hold VUSTX (Vanguard long-term treasury fund). As many of us know, this is not ideal because much of its holdings are of too short a duration.
You have EDV to help balance out VUSTX.
Just as your treasuries hit the 35% mark, VUSTX is at breakeven and EDV is showing a huge unrealized gain.

Would you-
A) sell VUSTX for a tax-neutral transaction. (You may or may not buy something different, like TLT, the next time you need more treasurys)
B) sell EDV because the whole point, after all, is to sell high, to make a profit.

2) You hold 30-YR bonds directly. You've got a bunch each of two bonds. They have virtually the same maturity date, but one has a much larger gain than the other. Which one would you sell? Or perhaps a little of each?

Other options for (1) and (2):
- Alternate taking profits with tax-neutral sales. Of course, we don't get to rebalance very often.
- It doesn't matter.

I actually hold all of the above. VUSTX, EDV and 30-YR bonds.
Any thoughts?

[dualstow]

No comments - really? Not even an "I was wondering the same thing?" 

[l82start]

i would love to help you out, but i don't have an answer for this one, i am sure someone will come along with one ..  
doesn't EDV have a transaction fee you need to account for?  if it does, the difference between tax neutral and transaction cost + taxes might be an easier decision...

[dualstow]

i would love to help you out, but i don't have an answer for this one, i am sure someone will come along with one ..  
doesn't EDV have a transaction fee you need to account for?  if it does, the difference between tax neutral and transaction cost + taxes might be an easier decision...

Good question! I'm not sure about any transaction fee associated with EDV. I'll have to look into that.
I'm beginning to wonder if the reason everyone is so quiet is that all their bonds are in tax-deferred accounts. But even then, I'm not sure if it makes more sense to sell the breakeven holding or the one making a big profit, or some of both.

[MediumTex]

I'm mostly tax deferred.

If you have a Vanguard account, buying and selling EDV is free (for those who weren't already aware of this).

Beware large taxable distributions from EDV.  An obscure investment as volatile as EDV is going to see hot money flow in and out occasionally, as it did in 2008-2009 (which resulted in a large 2009 year end distribution).

[l82start]

Good question! I'm not sure about any transaction fee associated with EDV. I'll have to look into that.
I'm beginning to wonder if the reason everyone is so quiet is that all their bonds are in tax-deferred accounts. But even then, I'm not sure if it makes more sense to sell the breakeven holding or the one making a big profit, or some of both.

all tax deferred here, held in in TLT

[AgAuMoney]

Ideally there would be no taxes or other transaction costs, and you would buy/sell to maintain the desired allocation to all components of each allocation.  That's kind of the way I used to manage my 401(k) accounts.    (In fact, one of my accounts would automatically rebalance at my choice of quarterly, bi-annually or annually to my pre-specified allocation almost to the penny.)

For example, if your 25% bonds was split into 10% individual treasuries, 10% VUSTX and 5% EDV then after your rebalance the components should be at the same 10/10/5 split.

The real world isn't ideal so we make adjustments.

If there are transaction costs at some point the transaction cost is too high relative to the size of the adjustment needed.  For example, maybe moving only 2% of the portfolio costs too much in transaction costs, so if EDV is at 6% or 7% you just let it ride because trying to get that 1% or 2% out and put it somewhere else is just too expensive.

If the assets you need to sell are in a taxable account,  then your transaction cost includes whatever tax rate on whatever gain you will realize through the sell.  You can either sell other assets to avoid realizing that gain, or you can sell losing assets in conjunction to offset the realized gain with a realized loss, or you just decide that the 15% of the gain (or whatever your rate) is just part of the transaction cost and you don't adjust if the cost is too high a proportion of the adjustment.

And of course there are all sorts of combinations of the above...  E.g. sell the gain, sell some loser to offset part of the gain, now the tax cost is a low enough percentage of the transaction size that you are OK with it.  Etc.

Bottom line, it is smart to consider transaction costs including the tax impact.  However do not make a stupid investment decision (or lack of decision) just because of a transaction cost.  At what point it becomes "stupid" is a question you have to answer for yourself...

[dualstow]

I appreciate the replies. I'll be nagging you guys again if my treasurys actually hit 35%, but that seems doubtful.
@MT my EDV is in my Vanguard Roth. (wipes forehead).

AgAuMoney wrote:

For example, maybe moving only 2% of the portfolio costs too much in transaction costs, so if EDV is at 6% or 7% you just let it ride because trying to get that 1% or 2% out and put it somewhere else is just too expensive.

Makes sense.

[Greg]

2) You hold 30-YR bonds directly. You've got a bunch each of two bonds. They have virtually the same maturity date, but one has a much larger gain than the other. Which one would you sell? Or perhaps a little of each?

I realize this is an old thread. Dualstow, did you ever come to a decision with this?

I would think for this option at least, if you had two sets of 30 year bonds that were very close in maturity and let's say the one has a large run-up (up 60%) and the other is only up 10%. If both are close enough in age, wouldn't it make more sense to sell the 10% one? I state this because normally you would want to lock in gains, but you have two options:

1.) You sell the 10% appreciated bonds enough to bring you down to the 25% band and you pay taxes on that. Then let's say the bond interest rate spikes up and your bonds lose a lot of money and a lot of those appreciations you had of the 60% gain are gone now.

2.) You sell the 60% appreciated bonds and pay the much greater amount of tax and then bond interest rate spikes as it did before and you lose a lot of money.

If both are very close in maturity, then both will be almost exactly the same affected by the rate spike. Both bonds would lose the same amount of money but if you sold the 60% you would be paying much more tax than if you sold the only 10% appreciated bonds.

This starts falling apart if the bonds are getting to be a few years apart, but for the bonds being close in age, I would think it is a no-brainer. Sell the lower appreciated bonds and keep from paying the tax man for a little while longer.

Does my thought process make sense for this?