The year-end represents an ideal time to rebalance your portfolio. Fears over the impact of the "fiscal cliff," or the inability of politicians to come to an agreement regarding finding the right balance between government spending and revenue, are only complicating matters. Below are five recommendations to rebalance your portfolio that take into account shorter-term concerns as well as a more sensible strategy over the long haul.
Shift Your Dividend Focus
If the Bush-era tax cuts are not renewed, the dividend income tax rate is set to revert from 15% for qualified dividends to personal income tax rates. This could mean a tax on your dividends as high as 39.6% at the top income tax bracket. Already, companies are rushing to get dividend payments into 2012 and declare special payouts that push the payouts into the current year, instead of 2013.
An ideal rebalancing activity for investors is to shift dividend-paying stock holdings into non-taxable or tax-deferred accounts. This may not be possible in all instances, but moving from a taxable account to a Roth IRA, traditional IRA or related tax-efficient accounts could result in sizable savings.
The expiration of the Bush-era tax cuts would also result in an increase in the capital gains tax from 15 to 20%. This isn't as significant as increase in the dividend tax but it's worth considering. Ideally, investors should re-emphasize a buy-and-hold strategy that emphasizes investing into solid, growing companies where capital gains taxes can be pushed well out into the future. Not selling a growing stock can lock up unrealized gains for many years and result in tax savings that add up over time.
Lower Your Bond Exposure
A number of highly-respected investors, including Hermes Chief Executive Saker Nusseibeh, are emphasizing stocks over bonds. "We're done with the bond markets. People are beginning to talk about [that] there are certain assets which can grow with inflation, which can pay a dividend and have strong balance sheets," said Nusseibeh in an interview with Reuters. In his mind, large global companies are great investment candidates at today's prices. As a result, investors could be well-advised to minimize bond exposure and shift into stocks, where appropriate.
Go International by Investing Here at Home
Look more specifically at the geographic spread of your portfolio. International markets, including emerging ones in South America and Asia, are still expected to outperform developed economies like the United States. As such, it makes sense to position portfolios for international growth, which stems from a growing market for middle-class consumers in key countries such as Brazil, China and India.
U.S.-based investors are unique in that many of the large companies headquartered here have already caught on to the compelling growth prospects of certain international markets. In fact, close to half of all of the sales of the S&P 500 stem from overseas. There is certainly a compelling argument to letting well-run, large companies navigate more uneven emerging markets and gain this exposure by investing in the domestic index.
Average into Your Assets
The above recommendations qualify as tactical approaches to shift into assets or areas of the market that could experience stronger near-term performance. A sensible rebalancing program will shift a portfolio toward its defined asset allocation, which is laid out in an investment policy statement. For instance, keeping an asset allocation mixed between half stocks and half bonds should be rebalanced at least annually, if not every six months or quarterly. Minimizing bonds within a reasonable range also makes sense.
The Bottom Line
Portfolio rebalancing is a vital component of any successful investment plan. The above strategies should help you sleep more soundly at night and keep a long-term perspective toward investing.