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Between travel, holiday shopping, charitable contributions and taking care of other year-end tasks, your December checklist is probably getting long.
But there’s one more item to add to your to-dos that can make a big difference for your investments and potentially your next tax bill: rebalancing your investment portfolio.
Rebalancing is all about getting your asset allocation — the amounts of your portfolio that you have in different asset classes, like stocks, bonds, real estate or even crypto — back in line with your investment plan.
This year, financial markets have taken a significant hit amid decades-high inflation and interest rate hikes, and you’ve likely seen that reflected in your investment accounts. As asset values change, the percentages of your total portfolio those assets comprise changes too.
If your stocks performed worse than your other assets, for instance, you might need to sell some better-performing assets and buy more stocks to get back to your targeted allocation.
Why now is a good time to rebalance
The S&P 500, a benchmark commonly used to measure the performance of U.S. stocks overall, is down around 18% for the year. Other financial assets have suffered, too.
Given the significant volatility in 2022, it's likely that the allocation of your stocks, bonds alternative assets and cash aren't in line with your intended strategic asset allocations, if you have not been consistently rebalancing, says Brian Farrell, wealth management advisor at Greenleaf Trust in Kalamazoo, Michigan.
How often investors choose to rebalance their portfolios can vary. Some rebalance monthly or quarterly, while others rebalance semi-annually or annually.
Clayton Gardner, a founder and co-CEO of the investing platform Titan says now is also an especially good time to check in because an end-of-the-year rebalance can come with major tax benefits.
Taking advantage of tax-loss harvesting
A portfolio rebalance lets you take advantage of something called tax-loss harvesting, which refers to offsetting gains in your portfolio with losses on other investments. Doing so can reduce your taxable income from investments, and the result is a lower tax bill next spring.
Here’s how it works: The IRS will allow you to use your capital losses to offset capital gains and — if you have more losses than gains — up to $3,000 of your income in a given year. If you have more losses than that, you can carry them over to future years (though the $3,000 limit still applies).
Experts say it’s a good idea to reinvest the money you made by selling your losing assets, but be wary. The IRS prohibits deducting losses if you’ve made a “wash sale,” which happens when you purchase the same security (or a “substantially identical” one) within 30 days of selling the original. That means that if you want to reinvest your money and take advantage of tax-loss harvesting, you’ll need to buy a different security or sit on the sidelines until the 30-day period is over.
The deadline to sell losing investments to offset gains for your 2022 taxes is Dec. 31.
Of course, no investing advice is one-size-fits-all. Depending on your portfolio allocations, Gardner notes that you could actually create gains when rebalancing that would take tax-loss harvesting off the table.
But seeing whether or not you can take advantage of this strategy is an especially good idea now, Gardner says. “If there's ever been a year to do tax-loss harvesting and rebalancing, it’s this year.”
Over the last decade, “we’ve never seen [this] breadth of a correction across virtually every asset class,” he adds. That means that most investors will see net losses in their portfolios, and those losses are likely to be much larger than usual.
In other words, you can get your portfolio back on track and potentially make a smart tax move all before we kick off 2023.
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