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Should You Derisk Your Portfolio?

Here's what to think about if you're heavy in stocks today.

The following is an excerpt from Christine Benz's recent webcast, Tune Up Your Portfolio in Uncertain Times. Watch the full webcast.

Christine Benz: What do we do with all of this? How do we create an action plan? I think it's important to approach this really getting back to your life stage. I would argue that if you've gone through this exercise, if you flagged some areas where perhaps you're taking too much risk in your portfolio, so if you found that your portfolio's equity allocation is really, really high, and you're planning to retire in the next couple of years, I would argue at that life stage derisking that portfolio is imperative. On the other hand, if you are someone who is in your 30s or 40s, there's probably less of a need to derisk in a really big way. You may want to make some changes around the margins. You might want to peel back from U.S. and put more and more money toward non-U.S. stocks. But it's a little less urgent if you are embarking on retirement in 20 years or more.

On the other hand, many people who are younger, who are saving for retirement are simultaneously saving for other goals. Maybe it's a home down payment or some other goal that's closer at hand, derisking those assets is mission critical. Even if you have a long time horizon to retirement, if you have other things that you want to accomplish in the next five or 10 years or even fewer, derisking that portion of the portfolio is really, really important. So, put that at the top of your list when it comes to deciding whether to take action.

The key issue is, if you've gone through this process and you've determined that you need to make changes, it's important to watch out for transaction costs. Although those are increasingly less of an issue, given that we've kind of moved into this no-transaction-cost environment. But a key thing to keep an eye on is tax costs that you might incur. That's one reason why if you've gone through this process and you need to make some tweaks, whether peeling back on U.S. stocks or whatever the case might be, it's best to start that process within your tax-sheltered accounts, so within your IRAs and 401(k)s, other retirement plan assets. Start that process within those accounts, because you can do all of the tinkering that you want within those accounts without triggering any tax costs. If you're subject to required minimum distributions, so if you're over age 72, and you're subject to those RMDs, I think it makes all the sense in the world to annually pull those RMDs from the positions that you're most overweight in. So, if you need to make changes to your portfolio, and you're subject to RMDs, why not do both at the same time? So, for a lot of RMD-subjective investors, my view is that peeling back U.S. stocks, specifically U.S. growth stocks, is probably a rich vein to mine if you're doing some rebalancing.

If you are moving on to your taxable accounts, so if you've done some repositioning within your tax-sheltered accounts, and you decide that your taxable accounts are too aggressive, or you want to make changes, a good thing to do to avoid triggering a tax bill is to potentially add new assets. So, if you're still adding to those accounts, to put the new additions to that portion of the portfolio into the underweight holdings. That's a tax-efficient way to rebalance your taxable accounts. You may or may not be able to get back to your target allocation using that strategy, but it does tend to be a good tax-efficient way to start, and it's certainly something that people who are adding to their portfolio should think about.