The Smart Way to Prune Your Stock Portfolio

Original post

Editor’s Note: If there’s one thing we can count on when it comes to investing, it’s that a bear market follows every bull market. (Just as a bull market follows every bear market.)

On Friday, Alex wrote about how far more money has been lost preparing for stock market corrections than in the corrections themselves.

Spreading your risk among different asset classes – and regularly rebalancing your portfolio – will sustain you far longer (and better) than keeping your money in cash and doing nothing at all.

That’s why The Oxford Club’s Bond Strategist Steve McDonald is hosting a FREE webinar on one of the least risky approaches to managing your money. In it, he’ll show you how to lock in predetermined returns of up to 154% on your nest egg.

It’s happening this Wednesday, September 12, at 3 p.m. ET. Click here to sign up now.

– Donna DiVenuto-Ball, Managing Editor


In my last column, we considered whether the time is right to get out of the stock market.

The short answer is no. (And that holds true even if the next step is down.)

The 10-year Treasury yields about 3%. Cash pays considerably less. And stocks – while far more volatile than bonds or Treasury bills – offer far superior long-term prospects.

However, there are investors who might reasonably consider paring back their equity exposure after the terrific bull market of the last 9 1/2 years…

Investors whose stock portfolios have done especially well. (Most Oxford Club Members, for example.)

Ten years ago, for instance, you may have had 60% of your portfolio in stocks and 40% in bonds. 

But now that the S&P 500 – with dividends reinvested – has more than quintupled from the market lows of March 2009, you might have as much as 90% of your portfolio in stocks and only 10% in bonds.

In that case, it would make sense to rebalance your asset mix and bring your portfolio back into alignment with your original allocation.

This is particularly true if you’re elderly or well into retirement. 

Warren Buffett’s mentor, Benjamin Graham, had a good rule of thumb: An investor should never have more than 80% – or less than 20% – of his or her portfolio in stocks.

The idea is that you should always keep at least 20% in bonds in case things go horribly off the rails. (Let’s not forget that – peak to trough – the market declined 89% in the Great Depression.) You should also keep at least 20% in stocks to earn a high enough return to comfortably exceed inflation. 

It’s important to realize that once you’ve made the decision to pare down your stock allocation, there are smarter ways to go about it. 

Begin by shifting from stocks to bonds in your retirement accounts. That way you won’t surrender a big chunk to the IRS and, depending on where you live, your state (or local) government.

You face up to a 20% federal tax on long-term capital gains and as much as 37% on short-term gains.

If you don’t have too much equity exposure in your 401(k) or other qualified retirement plan, you’ll need to sell off some positions in your nonretirement accounts to reach your desired asset allocation. 

Start by selling your losers rather than your winners.

Why? Because you want to cut your losses and let your profits run. If you’re truly attached, you can avoid the wash sale rule by buying the losers back after 30 days. 

This was a bigger consideration back in the days when spreads were large and commissions were high. But now that spreads are typically a penny or two and stock trades cost $5 or less, it’s no big deal.

By harvesting any losers, you’ll also have created capital losses to offset capital gains in your taxable accounts. 

In sum, once you’ve made the decision to reduce your equity allocation, make any shift in your retirement accounts first. Sell your losers second. And only then begin to realize capital gains in your nonretirement accounts. 

Doing the opposite – selling your winners, not offsetting the capital gains with realized losses, or leaving the gains in your retirement accounts untouched – is not a smart way to prune your portfolio. 

You’ll thank me on April 15. 

Good investing,

Alex