Many investors tend to look at what their portfolio has done recently instead of looking at what it is likely to do in the future. Behaviorally, they see a handful of stocks in a strong rally, making the portfolio grow. They also see a handful of positions that are not performing well. Why not sell these dogs and buy more of what is doing so well?
If you go to the grocery store and your favorite food is on sale, and there is nothing wrong with it, you will buy more. It should be the same with your investments, right? If you liked the investment before and nothing has changed except the price decline, why wouldn’t you jump at the chance to buy more at a lower cost?
The game is “buy low, sell high.” Active managers use these situations to rebalance a portfolio. They recognize the gains that have been made by trimming back the stocks that are performing well. They reinvest that money into sound assets that are at a good price.
We absolutely agree that an investor should manage their portfolio for their tax situation; however, tax strategies shouldn’t guide the portfolio management. When a portfolio has positions that have incredible growth, we recommend locking in those gains by selling a portion and reinvesting elsewhere. Rebalancing is an integral part of the investment process. If you held a market weight position and experienced exponential growth over the past year, you now have an overconcentration, which increases your risk. Portfolio decisions need to include a look forward to what might happen in the future. You must determine if there is still room to grow or if you will ride it back down by continuing to hold it. Price ratios can help in this matter by showing if underlying fundamentals have grown in step with the stock price.
We often see taxes as the main reason behind not wanting to sell the “winners” from a portfolio. In reality, you have two options: sell and take the gain and pay the taxes or wait until the stock falls before you sell and lose your profit. Capital gains taxes are only a portion of your overall gain. Many investors don’t readily see that a “winner” only needs to fall a small percentage before it loses what you would have paid in taxes.
For example, say you have a stock you purchased at $100, and over time it gained 70% (like some Energy stocks have done recently). If you were to sell it, you would have long-term gain of $70, taxed at 15%, or $10.50. If you insisted on keeping the stock, you need keep in mind that the stock price would only have to pull back 6.2% before it loses more in the price than you would have paid in taxes if had you sold.
Overall, if you can use profits to buy a quality investment at a lower price that likely has more room for growth, then selling for a gain isn’t a bad decision.
If you have questions on rebalancing your portfolio, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the March 11, 2023 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
