Fearing tax I didn’t rebalance my portfolio in Sep 2021 and now suffer higher losses!

Published: July 3, 2022 at 6:00 am

A reader writes, “Dear Sir, I read two articles that you had rebalanced your long-term portfolios twice last year (April and Sep 2021). I was in two minds after reading this. Should I rebalance now and book some profits into fixed income or should I wait a bit more? I decided not to rebalance because I was scared of paying taxes and thought would lose out on potential market gains.”

“Now the market has gradually corrected since October 2021 and I feel terrible at the missed opportunity. The loss I face today is much higher than the tax I would have paid on rebalancing. I have learnt my lesson now: rebalance like a robot once a year. I do not have a question but if you see it fit do share this experience anonymously with your readers so that they can avoid the same mistake. Thank you for everything”

We appreciate the reader for coming forth with his experience. The articles mentioned above are:

It is important for readers to appreciate that the markets corrected after I rebalanced is sheer dumb luck. I acted because I was uncomfortable sitting on gains. Things can and will go both ways: sometimes the market may correct after you shift some gains from equity to fixed income and sometimes it could move further up. No one can predict this. The same two situations apply to the reverse transaction: rebalancing from debt to equity.

The point is that one should rebalance regardless of the current situation or future outlook as long as the rebalancing is suitable for our personal goals. If you are new to investing then here are some resources to understand the ins and outs of rebalancing.

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Now as regards ” rebalance like a robot each year”, this is not necessary. Suppose your intended asset allocation is 60% equity and 40% fixed income. In the initial years of investing, you don’t need to rebalance the portfolio as long as the equity allocation stays within 55% to 65%. Equity will not stray beyond this each year. This is known as a 5% threshold rebalancing. In the latter years of investing, we should focus on de-risking – actively and systematically reducing equity allocation well in advance before a goal.

For the reader though, we learnt that in Sept 2021, the equity allocation was almost 10% higher than his target allocation so it is indeed a missed opportunity. However, he is only 34 and his retirement is about 20 years away. So there will be plenty of other chances to correct this “mistake” down the line and there is no need to regret it.

As regards taxes, let me give some numbers from my portfolio since I just filed my ITR. The amount of tax I paid for both rebalance events combined is only 1.6% of my annual investment for my goals (or only 19% of my monthly investment).

The tax paid is only 0.14% of my combined corpus (retirement + child’s future) as of Oct 2021 and only 0.17% of its value today. This is the price for safeguarding about 5% to 7% of my equity investment. I will pay this price happily every single time. In hindsight, we can state that this is much smaller than how much the market has corrected since Oct 2021.

Some might argue that these losses are “notional” while the tax is real. The loss is not notional because the time lost from Oct 2021 to June 2022 is lost forever. And the gains I have shifted to debt are much higher and quite “real”.

Tax is the peanuts we toss to the government on our way to becoming multi-crorepatis. Any action that is based only on saving tax is almost always wrong in personal money management. We therefore recommend rebalancing with a 5% threshold in the initial years of investing and afterwards de-risk the portfolio (which will also rebalance it) in a systematic goal-based manner. Try this if you would like to get started the right way and create an investment strategy independent of market conditions: Basics of portfolio construction: A guide for beginners.

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