Legal   |   ADV   |   Privacy   |   CRS

How to Rebalance a Stock-Heavy Investment Portfolio

The stock market has been on a tear this year as concerns about the pandemic begin to wane and the economy reopens. As of mid-November, the S&P 500 was up 27% for the year, on top of the 18% gain it enjoyed last year.

Of course, this is probably good news if you own common stocks. But it could lead to a potential problem by knocking the asset allocation in your investment portfolio out of whack. For example, if you had a 60% stocks-40% bonds allocation at the end of 2020, this would have shifted to a 66% stocks-34% bonds position now.


Maintain Portfolio Diversification

Diversification of assets among the three main classes of stocks, bonds and cash equivalents is one of the keys to successful long-term investing. So when this occurs, it often makes sense to rebalance the portfolio to maintain proper diversification.

This can be done by selling some stock positions and using the proceeds to buy more bonds or cash equivalents. Keep in mind that this may have tax consequences as you realize capital gains, which are currently taxed at favorable long-term capital gains rates if the stock was held for at least one year.

Another option is to take advantage of auto-rebalancing options offered by some brokerage firms and retirement plans. With these, your holdings are automatically adjusted periodically (such as twice a year) to bring your portfolio back to your target allocation of stocks, bonds and cash equivalents.

Yet another idea is to take any dividend and capital gains distributions you automatically reinvest in more shares in cash instead. You can then use the money to purchase bond funds, Treasury inflation-protected securities or other diversifying assets, or just leave it in cash.

Diversifying Within Asset Classes

In addition to diversifying among stocks, bonds and cash equivalents, you can also diversify your holdings within each asset class. With stocks, for example, you can own international and domestic stocks, mutual funds and ETFs as well as the securities of small-cap, mid-cap and large-cap companies. You can further diversify your stock portfolio by investing in companies across a wide range of different industries such as healthcare, technology and telecommunications.

Many investors fail to take advantage of the potential benefits of international diversification, in particular. The performance of stock markets varies greatly all around the globe, but a lot of U.S. investors have a “home country” bias and only invest in domestic stocks. However, less than half of the world’s economic activity occurs in the U.S. — so not diversifying internationally could potentially mean missing out on economic growth and equity returns in other nations.

Donate or Gift Appreciated Stock

Another way to rebalance an investment portfolio is to donate a portion of your stock holdings to charity or gift them to family members. Now may be an especially good time to make charitable donations of appreciated stock as part of your year-end tax strategy.

When you donate appreciated securities to qualified charities instead of cash, you avoid paying capital gains taxes on the appreciation that are currently as high as 20%. You can also deduct more than your cost basis in the stock. So if you donated a stock currently worth $12,000 that you paid $3,000 for five years ago, you’d save $1,800 in capital gains tax (at the 20% rate) and be able to deduct $12,000 instead of $3,000 on your federal income tax return. 

One efficient way to make this type of charitable donation is by using a donor advised fund (DAF). With this strategy, you can contribute stock now and decide later which charities will receive your gift. DAF contributions are deductible during the year when they’re made, so be sure to make the donation before December 31 if you want to deduct it for tax year 2021.

A Good Problem

Having an overweighted stock position in your investment portfolio is certainly a good problem to have. Consider whether these strategies would be appropriate to help you bring your portfolio back into the right balance.

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.