When I find something I like, I stick with it. My favorite cookie recipe? I will use it forever. My super comfy slippers? I will wear them until they have holes in the sole (then find another of the same pair). Shampoo? I’ve used the same brand since high school.
What I am about to explain to you is therefore just as difficult for me as it is for you:
Gather up your favorite stocks and then… SELL THEM.
Well, sell a portion of them. This is called rebalancing.
Why would you ever want to sell your favorite, best-performing stocks? Let me tell you:
1) You don’t want to fall victim to “Dotcom Bubble Euphoria”
Does this chart look familiar to anyone? Yahoo Finance
This is the NASDAQ, an infamously tech-heavy stock index, from 1987-2006. This is the type of chart you will see when you hear the term “stock bubble.” A huge fast expansion and then… a POP.
So, what happened here? Why did the index rocket to 4,696 points before plummeting to 1,172 points?
People were hyped about the internet. New online companies popped up left and right and people wanted in on the excitement. Venture capitalists and average investors alike poured money into tech startups. There was serious FOMO happening as neighbors talked about which new tech stock they just got into. Investors experienced 50%…60%…80% annual returns! Investors held these stocks, hoping they would climb even further. The problem was… these companies weren’t making any money!
When these companies started to fail, they took the stock prices of the more established tech companies down with them.
The house of cards collapsed. Investors that got caught up in the euphoria lost big.
Rebalancing could have saved them!
Rebalancing is the process of carving off profits from your best-performing assets and reinvesting the money into your underperforming assets.
For example, your $100,000 portfolio is comprised of 60% stocks ($60,000) and 40% bonds ($40,000). Your stocks grew by $20,000 – great news! Your bonds stayed flat. So, do you think you are still at 60/40?
No, your portfolio is now at 67% stocks.
That means your risk level just crept up. Gone unchecked, the risk will continue to creep higher, leaving you susceptible to a bubble-like event! Take of those stock gains and reinvest them into your bonds. Now you are back at a happy 60/40 😊
Remember, the stock market is only truly risky over the long term if you are undiversified.
2) You don’t want to kick the tax bucket further down the road
I have to admit something. Every time I hear someone complain about paying taxes on their investments, I cringe.
Aside from giving to charity, do you know the only two ways to avoid capital gains tax?? You can either lose money or die…. I for one want to make money and live (even if that means a little tax along the way).
There are temporary ways to avoid paying taxes. Some people avoid rebalancing their portfolios because they don’t want to sell a profitable stock. When you sell a stock, you do incur the capital gains tax (which is a very low tax, by the way).
So, some people will let their stock allocation inflate solely because they do not want to pay taxes in that year. But guess what? When they need money from the portfolio later, they have only kicked the tax bucket down the road! They will need to pay tax on even higher gains (assuming there is still a gain).
Don’t let taxes bully you into not selling your stocks. If you have an accountant who tells you otherwise, find a new one! WISE INVESTMENT DECISIONS ALWAYS TRUMP TEMPORARY TAX SAVINGS.Wise investment decisions always trump temporary tax savings. Click To Tweet
There is ONE exception to this rule:
If you are elderly and fully expect to leave your investment account to a beneficiary soon, you can leave your stocks alone. Your beneficiaries will not have to pay taxes on the growth due to the super helpful step up in cost-basis.
3) Your attachment to one stock might mean you are missing out on other opportunities
There are some really cool companies out there! We might hold a company’s stock because they produce interesting products, have super ethical operations, and/or because we fondly remember our grandpa working at their office years ago.
Because we value these companies so much, we don’t want to sell any of the stock.
However, just like there are many other fish in the sea… there are many other tickers on the S&P. ♥Just like there are many other fish in the sea… there are many other tickers on the S&P. ♥ Click To Tweet
Don’t let your love for one stock prevent you from properly diversifying and rebalancing your portfolio. There are many good investment opportunities out there, and you don’t want your devotion to one stock to cause you to miss out them.
It is really easy to let our emotions and fear impact our decisions. Unfortunately, emotional investment decisions can cause irreparable damage. If you invest on your own, take precautions. Don’t let yourself make a snap decision or get lost in the hype! Make a plan to rebalance regularly. Ask me any questions you might have about investing. I will do my best to point you in the right direction!