Rebalancing: the capital gains conundrum

Tax just makes asset allocation decisions even more important when changing strategy

Rebalancing: the capital gains conundrum

Taking a short-term hit on capital gains tax in order to rebalance your allocation can keep an investor’s strategy on track with more muted returns around the corner.

That’s the view of Kurt Reiman, managing director and chief investment strategist at BlackRock, who said that failure to adjust to new market conditions could mean people do not deviate away from risk or move towards opportunity.

A roadblock for many, however, is the financial repellant of capital gains tax. Reiman said that this cost means investors and advisors must think long and hard about tactical portfolio shifts.

He said: “That’s why these strategic asset allocation decisions are so important because it will imply an automatic rebalancing. There is an aversion to having to pay taxes on gains, which is sometimes going to lock you into a higher-than-desired allocation to winners.

“I don’t want to have to send a cheque to the government just because I have cut my exposure to US equities to redeploy it to say emerging markets. You have stocks that have done phenomenally well, so there are winners. If you did nothing with your portfolio, if there was no new money added to your portfolio dedicated to non-US and then that US share has just grown in proportion to the rest of the portfolio, it’s a risky move.

“It’s better to take the capital gain and rebalance over time. Not too often, because the rebalancing implies some sort of cost, and just make sure you don’t get outside your desired comfort zone.”

While capital gains is a tough pill to swallow for some, Reiman said that investors have to adopt a more active stance given where we are in the cycle.

He said: “We’ve had a pretty good run in financial markets, bond yields have hit their lows and we’ve seen their lows in the cycle; they’re not likely to go lower.

“Stocks are not cheap any more. We’ve gotten some good returns so future returns from here are going to be more compressed. Investors have their goals and they may either be undersaved or under-risked, and so we would at first advise them to get a savings strategy and asset allocation that is going to achieve the outcomes that the investor wants.

‘But because of the historical performance we have had so far, with more muted returns in the future, it requires a more active stance on the part of investors to take these tactical shifts to either deviate away from where the risk is or move towards where the opportunities lie.”


Related stories: 
The biggest risk investors should guard against
The net-worth battle ground for advisors