Trimming stocks and funds in a down market can be like ripping a bandage off a scab. It might hurt at first, but the healing can accelerate once you rebalance your portfolio.
Like many problems, first you need to get over the denial, then take action. Use our tips and tactics from expert wealth managers to sell, hedge, cover and donate stocks to help mend and optimize your portfolio and position it for future growth.
If you've delayed taking action, you're not alone. Even top traders can become overly fond of previously top-performing equities. A lot of investors who were enamored with the FANG stocks — Meta (Facebook) Amazon, Netflix and Alphabet (Google) — have suffered big losses in their portfolios this year.
It's best to look ahead, not back. And there's never a wrong time to check your portfolio allocation across stocks, bonds, cash, industries and world regions — especially after a big move up or down in the markets. It might be time to limit exposure to hard hit areas.
"There's that old adage that concentration creates wealth and diversification protects wealth," said Peter Tortorici, director of high-net-worth consulting at Janney Montgomery Scott. "That's been the conversation over and over again with clients."
How Often Should You Rebalance Your Portfolio?
Figuring out how often to rebalance is dependent on your risk tolerance, as well as whether you've made any life changes. "When your allocations have changed meaningfully from your risk tolerance, look for opportunities to trim your exposure," said Robert Haworth, senior vice president and senior investment strategist for wealth management at U.S. Bank.
Checking quarterly is a good idea, and look "very seriously at all your positions once a year," said Haworth. If you're working with an adviser, they should be checking weekly or perhaps daily in today's choppy market.
Before you rebalance, you need to analyze what you're trying to achieve. "What outcomes are you trying to solve for," said John Harty, a wealth adviser with Carson Wealth, a division of Carson Group. You may be seeking to reduce risk, plan for retirement or harvest a tax-loss, Harty notes.
Is your nest egg overly dependent on your employer's fortunes due to stock and options? Think very hard about the risk you're taking.
"It's possible that a bad turn for the business could lead to both the depletion of your wealth — due to a drop in the value of the stock — as well as a possible loss of your primary source of income," said Tortorici.
Selling Strategies
Some selling strategies are simple, others are much more complex. Let's start with the easy ones. Get over the emotional side of selling and understand that selling when a stock is down can be a plus. You're getting rid of an investment that's not performing and freeing up assets for one with better prospects.
Selling stocks for losses also allows you to generate tax deductions. And donating stocks can help cut taxes too. This is another favorite divesting move if an investor is charitably inclined.
"Instead of selling your shares and paying taxes on the gain, donate your position and get tax deductions," said Tortorici. Typically this is done through donor-advised funds, says Tortorici. Firms that have those funds include Eaton Vance, National Philanthropic Trust, American Endowment Foundation, Charles Schwab and Fidelity.
Options, Stock Lending, Exchanges
Using options to reduce stock losses requires more study. Through an option contract, you can buy puts to protect your stock price down to a certain level. A put gives you the right to sell a stock or index at an agreed price by a specified date. But that protection costs money.
One way to pay for "the protection is a zero cost collar," said Tortorici. What's that? You sell call options to generate income, which then helps pay for the purchase of the put contracts. But "selling those calls caps your upside," he said.
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Another way to ease the pain of a stock that's fallen is to sell calls on the stock to generate income. The income offsets some of the decline of the stock, making it less painful for you to keep your position.
Lending shares is another way to mitigate the loss of a stock you want to hold. Tortorici says his firm has "a fully paid securities lending program." Using this program, a client "signs a document to lend out stock positions in their accounts to other banks for short-seller interest." With these contracts, you still own the stock, it's just on loan. Interest is then paid to the shareholder if a stock is lent out.
Tortorici says high-net-worth clients (or investors with Qualified Purchaser status) can also use an exchange fund to transition from stock concentration risk to broad equity market risk. Eaton Vance and Goldman Sachs are two firms that run exchange funds. These funds usually include a basket of stocks that track an underlying index. Any contributions of appreciated stock to an exchange fund are generally not taxable under current federal tax law.
"You're not technically selling your stock so there's no immediate tax consequences," said Tortorici. But like other funds you'll pay fees and expenses and there are complexities involved in using this type of fund.
If the value of your stock goes down, and the broad fund does better, you'll benefit. But, "If your stock appreciates more than the fund you'd miss out on that upside," he said.
"It's a great estate planning tool," Tortorici said. "And it's a way to diversify your portfolio while deferring taxes."
Lastly, make sure you know what's in the ETFs and mutual funds you own. "There's quite a bit of overlap within strategies for these funds," said Haworth. And sometimes active fund managers "will go outside their benchmark to make returns." That means you many end up with overlap across funds and more concentration in an equity, industry or region than you intended.
