Q: How do you suggest rebalancing in a TAXABLE account? I have always automatically reinvested my dividends and capital gains, but then my allocation balances get off and I would have to sell funds, incurring extra income taxes, to rebalance. What about NOT automatically reinvesting and then periodically (once a quarter?) reinvesting to keep my asset allocation balanced? Or do you have a better method?
A: Rebalancing is one of the most difficult challenges for investors. For people who have both taxable and tax deferred investments, it is often possible to do some of the rebalancing within the tax-deferred part of the portfolio. It is not required that a certain asset allocation be achieved within each account. Assuming similar amounts in taxable and tax deferred accounts, you could end up 60/40 in one account and 40/60 in the other to for an overall 50/50 balance. I like the idea of accumulating the dividends and capital gains to give you more money to invest so you can minimize taxes and other costs. Of course the most efficient way to rebalance is with new money. For most people rebalancing every 1 to 2 years is often enough. The longer you wait to rebalance the more money you are likely to make. Rebalancing is another topic I will address in my performance series of articles.