Is Santa Checking His Portfolio Twice?



It really is the most wonderful time of the year. Yes, our holiday season may look and feel a lot different in 2020. But childlike enthusiasm will still abound, and family celebrations (albeit smaller) will still take place. I’ll miss the larger gatherings of friends and extended family, but I’m thankful for the other traditions that will carry on this holiday season.

This time of year is also a good opportunity for investors to take one final look at their investment portfolios before the calendar flips to January. It may not be as exciting as anticipating a visit from Santa, but repositioning certain portfolios after a recent run-up in risk asset prices may help mitigate future volatility.

The Gift of Rebalancing

I’ve long been a proponent of the view that portfolio rebalancing is one of the best forms of market timing. The reason? It forces us to buy assets that have depreciated/underperformed and sell those that have appreciated/outperformed. Sure, we sometimes find ourselves in a long-term trending market where we sacrifice some upside. But, as the data shows, a simple strategy of rebalancing once per year can help preserve capital during market pullbacks.

Just consider the recovery period of a buy-and-hold portfolio versus that of the yearly rebalance portfolio. In the market pullback of 2000–2002, investors in a rebalanced portfolio recovered their portfolio value in 15 months. Buy-and-hold portfolios, on the other hand, took almost double the time to recover what was lost in the sell-off. The difference wasn’t as dramatic in the 2008 sell-off, with investors able to recover their peak portfolio values by October 2010.

Goals for the New Year

Rebalancing is important, but it should not be done in a vacuum. Careful consideration needs to be given to when you execute the trades and in what types of accounts. In retirement or qualified accounts, where investment gains accrue tax free, the decision is relatively straightforward and rebalancing can occur at any time. In taxable or non-qualified accounts, however, investors need to be very thoughtful about the timing of rebalancing decisions.

Anything can happen in the last week of the year, of course. But as of right now, we’ll close 2020 with solid gains in equities. As a result, many investors may be a little more overweight stocks relative to bonds across their balanced portfolios. Delaying the decision to rebalance until early next year may be a worthwhile consideration, as the tax bill for selling equities at that time won’t come due until April 2022. Also, you may have the benefit of harvesting losses for the remainder of 2021 to offset the gains incurred during your January rebalance.

Online Shopping: Capital Gains Distributions

There are other important aspects for investors to consider at year-end when looking at their portfolios. One of them is the fact that mutual funds typically make their capital gains distributions around this time. Mutual fund shareholders of record will be subject to these distributions and are required to pay taxes on those gains. This is true regardless of how long an investor has held the mutual fund. Investors in taxable accounts should be mindful of this dynamic and may want to evaluate whether or not they want to purchase a fund right before it is scheduled to make a capital gains distribution.

Determining when mutual funds are paying these distributions used to be a somewhat laborious exercise that involved visiting each company’s website to look up the date and amount being paid for each portfolio holding. There are now a few websites that track and aggregate this information to make it much easier for investors to evaluate the impact on their taxable accounts. One of my favorite resources was developed by our friends at BlackRock through their Tax Evaluator tool. In addition to providing all of the relevant details (e.g., the amount and date of each distribution), it also provides an exchange-traded fund equivalent if an investor is interested in another investment with similar exposure as the mutual fund in question.

An appropriate analogy relates to Christmas shopping. In the past, we all used to go to the mall; today, we shop on Amazon. Previously, we had to visit each fund company’s website to determine capital gains distribution information. Today, we have resources like this one from BlackRock. I may miss the food court and the people watching at the mall, but I much prefer the convenience and ease of today’s shopping experience.

‘Tis the Season

Navigating the capital gains distribution season is much easier now than in years past, and I encourage all to evaluate their own accounts before year-end. Instead of milk and cookies, I’ll leave a note reminding Santa to do the same. Happy holidays to all!

Please consult your member firm’s compliance policies prior to utilizing any applications or tools discussed in this post.

Editor’s Note: The original version of this article appeared on the Independent Market Observer.