Taxable PP and 35% Re-balance Band

[buddtholomew]

What options are available to a taxable PP investor when an asset reaches 35% of the portfolio? I am primarily interested in minimizing taxes but still stay within the 15/35 bands. I also have cash outside of the portfolio if required. I'm sure there are several options and I am interested in how others have managed the situation historically.

[Xan]

What's wrong with just rebalancing?  Yes, there'll be some tax implications, but that's how you capture volatility.  And I'm presuming there'll be some loss in the losers which will offset some of the gains in the winners.

[notsheigetz]

What's wrong with just rebalancing?  Yes, there'll be some tax implications, but that's how you capture volatility.  And I'm presuming there'll be some loss in the losers which will offset some of the gains in the winners.

If you're stuck with only a Taxable PP how would you go about capturing the losses? Are you suggesting to sell and repurchase after 30 days to avoid the Wash Sale?

I think MT and Craig talked about this in the book. If my memory is correct I think they said not to worry about going all the way down to 25% if the tax bite is too great - just do enough to get safely under 35%. I don't have this problem yet but I can see myself arriving there since I have stock accumulating in a taxable account.

[buddtholomew]

On a sizable portfolio, the tax implications of selling to 25% are substantial. What are the mechanics of offsetting gains with losses? Can someone illustrate with an example? Assume equities hit 35%, gold and treasuries at 20% each.

[dragoncar]

This is why some of us but the lagging asset even though it may not backtest as well in tax deferred

[rickb]

Let's say you started with $100K ($25K each) in SHY, GLD, TLT, and VTI, and now those holdings are worth $25K, $20K, $20K, and $35K (not very realistic, but it's an example).  To rebalance (ignoring taxes), you sell $10K of the VTI and buy $5K each of the GLD and TLT.  If you want to offset the gain in VTI you have to realize the losses in the other two.  So you sell all of the GLD and TLT and either

1) wait 30 days before you buy back the $20K you sold and another $5K in each
2) buy $25K each of something else that is not "substantially identical" in the eyes of the IRS (for example, you might switch GLD into GTU and TLT into VUSTX)

You should consult a tax adviser if you're considering the second approach.  I'm not a tax professional, but it seems likely to me that within each asset class "substantially identical" sets would be:

Gold: ( GLD = IAU = SGOL ) != ( GTU = PHYS ) != CEF != SLV -- not sure about physical coins, but others have said wash rules don't apply (in which case, I suppose you can sell them and then buy them back the next day - and report the capital loss on the sale)

LT Bonds: don't really know, but I'd think TLT != VUSTX != individual bonds, definitely TLT != EDV

Stocks: (VFINX = any S&P 500 index fund or ETF) != (VTI = FSTMX = any total stock market index fund or ETF)

[Tyler]

Things like tax loss harvesting, continuous rebalancing with new funds, or splitting the rebalance between December & January to spread income across multiple tax years can all help you in certain situations.

That said, so much depends on your personal situation (income, state, etc) that it probably is worth it to talk to a good tax adviser.

[rocketdog]

Let's say you started with $100K ($25K each) in SHY, GLD, TLT, and VTI, and now those holdings are worth $25K, $20K, $20K, and $35K (not very realistic, but it's an example).  To rebalance (ignoring taxes), you sell $10K of the VTI and buy $5K each of the GLD and TLT.  If you want to offset the gain in VTI you have to realize the losses in the other two.  So you sell all of the GLD and TLT and either

1) wait 30 days before you buy back the $20K you sold and another $5K in each
2) buy $25K each of something else that is not "substantially identical" in the eyes of the IRS (for example, you might switch GLD into GTU and TLT into VUSTX)

You should consult a tax adviser if you're considering the second approach.  I'm not a tax professional, but it seems likely to me that within each asset class "substantially identical" sets would be:

Gold: ( GLD = IAU = SGOL ) != ( GTU = PHYS ) != CEF != SLV -- not sure about physical coins, but others have said wash rules don't apply (in which case, I suppose you can sell them and then buy them back the next day - and report the capital loss on the sale)

LT Bonds: don't really know, but I'd think TLT != VUSTX != individual bonds, definitely TLT != EDV

Stocks: (VFINX = any S&P 500 index fund or ETF) != (VTI = FSTMX = any total stock market index fund or ETF)

I'm no tax expert, but this looks pretty solid to me.  I like the way you broke down the GOLD ETFs, too.  I looked them up and here's why the differences:

GLD = IAU = SGOL
All are open-end ETFs

GTU = PHYS
Both are closed-end ETFs

CEF
ETF holding 50/50 gold/silver

SLV
ETF holding 100% silver

[buddtholomew]

What options are available to a taxable PP investor when an asset reaches 35% of the portfolio? I am primarily interested in minimizing taxes but still stay within the 15/35 bands. I also have cash outside of the portfolio if required. I'm sure there are several options and I am interested in how others have managed the situation historically.

It seems to me that if you have extra cash, and don't want to pay taxes on your stock gains, simply use the cash to increase holdings on your other assets and leave the stocks alone.

This option is the least complex, but some may argue that adding additional funds to the PP from cash increases the amount of capital at risk. This POV can be debated as IT munis come with their own risk profile.

[rickb]

GTU = PHYS
Both are closed-end ETFs

CEF
ETF holding 50/50 gold/silver

More precisely, GTU, PHYS, and CEF are all closed end funds (not ETFs).  There are old threads discussing the differences, see http://gyroscopicinvesting.com/forum/ht ... ic.php?t=3 or http://gyroscopicinvesting.com/forum/ht ... ic.php?t=1.

[rocketdog]

GTU = PHYS
Both are closed-end ETFs

CEF
ETF holding 50/50 gold/silver

More precisely, GTU, PHYS, and CEF are all closed end funds (not ETFs).  There are old threads discussing the differences, see http://gyroscopicinvesting.com/forum/ht ... ic.php?t=3 or http://gyroscopicinvesting.com/forum/ht ... ic.php?t=1.

Ah, thanks.  I thought they were still ETFs, only closed, like when they close a Mutual Fund. 

[buddtholomew]

What options are available to a taxable PP investor when an asset reaches 35% of the portfolio? I am primarily interested in minimizing taxes but still stay within the 15/35 bands. I also have cash outside of the portfolio if required. I'm sure there are several options and I am interested in how others have managed the situation historically.

It seems to me that if you have extra cash, and don't want to pay taxes on your stock gains, simply use the cash to increase holdings on your other assets and leave the stocks alone.

Am I looking at this correctly? Does buying the lagging asset/s to re-balance the portfolio require the investor increase their account by 40%? I am calculating the dollar amount to re-balance the PP after an asset reaches the 35% limit. Also, depending on the % fluctuations in the lagging assets, you may contribute to assets that are well within their tolerance bands before the influx of additional money. Again, this is in a taxable account and I would prefer not to realize any capital gains.

[rickb]

What options are available to a taxable PP investor when an asset reaches 35% of the portfolio? I am primarily interested in minimizing taxes but still stay within the 15/35 bands. I also have cash outside of the portfolio if required. I'm sure there are several options and I am interested in how others have managed the situation historically.

It seems to me that if you have extra cash, and don't want to pay taxes on your stock gains, simply use the cash to increase holdings on your other assets and leave the stocks alone.

Am I looking at this correctly? Does buying the lagging asset/s to re-balance the portfolio require the investor increase their account by 40%? I am calculating the dollar amount to re-balance the PP after an asset reaches the 35% limit. Also, depending on the % fluctuations in the lagging assets, you may contribute to assets that are well within their tolerance bands before the influx of additional money. Again, this is in a taxable account and I would prefer not to realize any capital gains.

Yes, if you want to rebalance by adding assets when one asset reaches 35%, then you'll need to increase the (current, not original) size of the portfolio by 40%.

If (stocks+bonds+cash+gold) = CURRENT, and (say) stocks=35%*CURRENT

then to rebalance you want stocks=bonds=cash=gold, and if you're only adding, then each will also be 35% of the current total, so the new total will be

4*(35%*CURRENT), which is 140%*CURRENT

In general, to rebalance by only adding then the new total will be 4 times the max current asset.  If one asset has reached 15% then the new total will be at least 13.3% (but always less than 40%) more than the current total.

Whenever you rebalance you're extremely likely to be adding to (or subtracting from) 3 individual assets that are within their rebalance bands.  All this is saying is that it's very unlikely that 2 or more of the assets simultaneously drift out of their bands.

Another option might be to do what Clive called "halfway rebalancing".  If one asset hits 35% then rather than rebalance to 25/25/25/25 rebalance so the max asset is 30%.  If you're rebalancing by adding, then this increases the size of the portfolio by 20% rather than 40% - but you may not end up very balanced (best case is after rebalancing you're 30/23.3/23.3/23.3, worst case you're 30/30/20/20).  If one asset is in a directional trend (and stays in that trend), halfway rebalancing will work out better than full rebalancing.  But if the trend reverses, with halfway rebalancing you end up worse off.

[buddtholomew]

This looks like a less viable option as larger portfolios require a significant influx of new funds to rebalance. Does it ever make sense to not rebalance the portfolio at all?

[Xan]

I wouldn't rebalance before I hit my pre-determined bands, but I'd love to rebalance, even in taxable.  It's buying low and selling high.  So there are some taxes to be paid.  It's better to take profits and pay some tax than to lose them completely!  If you don't rebalance, you end up being way too heavy in some particular asset, that is, you're no longer diversified enough and you don't have a PP.

[rickb]

This looks like a less viable option as larger portfolios require a significant influx of new funds to rebalance. Does it ever make sense to not rebalance the portfolio at all?

IMO?  No.

If you don't rebalance what happens is your portfolio can become increasingly sensitive to the ups and downs of a single asset class.  If you're striving for safety this is a bad thing.

It seems like your issue with rebalancing boils down to paying the tax bite.  What you're trading off here is the chance that by not rebalancing (and paying taxes now) you'll ultimately be better off than if you rebalance and bite the bullet (paying taxes now).  The main variable here is the future course of the asset that is currently outside your rebalance bands.  If it's at 35% and keeps going up (forever) you're better off not rebalancing.  If it's at 35% and crashes tomorrow, you're better off rebalancing and paying the tax bite. 

You've got to ask yourself one question: "Do I feel lucky?" Well, do ya, punk? -- Dirty Harry

[buddtholomew]

I currently have an investment in IT-TE municipal bonds that I can exchange to rebalance lagging assets when an upper band is breached. I can do this once, but this plan of rebalancing will not scale as the amount invested grows. It appears as if I will at some point have to realize capital gains in an asset. I will look to offset with losses at that time and perhaps remain un-invested to avoid wash sale violations. Have I exhausted all options?

[Pointedstick]

If you hit a band, IMHO you should just rebalance and get it over with. We all dislike and work to minimize Uncle Sam's bite, but capital gains taxes from selling appreciated investments in taxable accounts is just a fact of life. Consider how fortunate you are to have sufficient investments that you overflowed your tax-sheltered accounts. It's a great position to be in. There are much worse problems out there than having to pay capital gains taxes on appreciated stocks.

Offsetting your gains with capital losses elsewhere is an option, but with a large portfolio it can be difficult since I believe you are only allowed to use $3,000 worth of capital losses per tax year in this manner.

[buddtholomew]

If you hit a band, IMHO you should just rebalance and get it over with. We all dislike and work to minimize Uncle Sam's bite, but capital gains taxes from selling appreciated investments in taxable accounts is just a fact of life. Consider how fortunate you are to have sufficient investments that you overflowed your tax-sheltered accounts. It's a great position to be in. There are much worse problems out there than having to pay capital gains taxes on appreciated stocks.

Offsetting your gains with capital losses elsewhere is an option, but with a large portfolio it can be difficult since I believe you are only allowed to use $3,000 worth of capital losses per tax year in this manner.

Thats not entirely accurate. The 3K limit is the amount you can deduct in losses after offsetting gains and losses. 13K in losses can offset 10K in gains with an additional 3K of those losses deducted from taxable income.

[Pointedstick]

Oh, good to know! Thanks for the clarification.