The Importance of a First Half Reassessment


Early July is not a time we automatically think about things like taxes and portfolio rebalancing. But before you head for the beach, it could pay to reset your strategy for the second half of the year.

If you haven’t yet, you’ll soon receive second-quarter statements from mutual fund companies, brokerages and banks where you have accounts. That makes it easy to see whether your mix of stocks, bonds and cash suits your long-term plan.

A typical investor who last rebalanced at the start of the year may not be too far off target. But if you rebalanced after the end of the first quarter March 31, you could be way off, since stocks have boomed.

Whenever you rebalance, it’s worth reassessing your asset allocation plan. Chances are your mutual fund companies and brokerages have online allocation tools to help with this calculation. Morningstar Inc.(Stock Quote: MORN), the market-data firm, has a good one on its site.

It shows that a 40-year-old with a moderately risky investing style might put 15 percent into cash, 35 percent into bonds, 32 percent into big-company stocks, 10 percent into small and mid-sized stocks, and 8 percent into foreign stocks.

Because the markets are volatile, it doesn’t pay to rebalance more than once or twice a year. Do it every month and you could find yourself reversing moves you’d made not long before, racking up trading costs and taxes unnecessarily.

To minimize taxes on gains from holdings sold at a profit, do as much rebalancing as possible in tax-favored accounts like 401(k)s and IRAs. So long as all your holdings taken together meet your asset allocation goals, it doesn’t matter if individual accounts are off target.

While tax issues should not dominate investment decisions, they shouldn’t be ignored, either. If rebalancing requires that you sell off just part of a taxable holding, such as a mutual fund you’ve invested in over time, you can sell the shares for which you had paid the highest prices. That way, you will either minimize the taxable capital gain or book a loss.

In fact, this is a good time to look for losses, which are investments sold for less than you’d paid. At tax time, losses can be used to offset gains on other investments sold for more than you’d paid for them.

And if your losses exceed your gains for the year, you can use them to reduce your taxable income by up to $3,000 a year. Net losses of $3,000 could reduce your federal income taxes by $750, assuming a 25 percent tax bracket. Bigger losses can be “carried forward” to offset gains or income in future years.

Rebalancing typically requires reducing or building up certain asset classes, such as large-company stocks, and you may have a number of holdings to select from in any given class.

Tax issues aside, deciding which holdings to sell should be done without regard to how each has performed in the past. The key question is how well you expect it to do in the future.

Ask: If I had extra cash to put to work, would I buy this stock, bond or fund today? If the answer is “no,” it should be sold. If the answer is “yes,” the holding should be kept or enlarged.

If you are putting 10 or 15 percent of your portfolio into cash, as the example above suggests, use the search tool to find top-paying certificates of deposit. It could pay to use a laddering strategy that includes long-term CDs with higher yields alongside shorter-term ones that pay less but give you quicker access to your money.

For example, you could get a 36-month CD from AIG Bank (Stock Quote: AIG) yielding 2.91 percent, a 24-month one from Bank of Internet (Stock Quote: BOFI) paying 2 percent and a 12-month CD from your neighborhood bank paying the national average of 1.2 percent. The CD Ladder Calculator can show what any mix of CDs would earn all together.

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