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STOCK MARKET INDEXES are at all-time highs, share prices are expensive relative to earnings and global economic growth is slowing. Is it time to consider rebalancing our portfolios and perhaps adopting a more defensive approach?
If you believe in rebalancing—maintaining a relatively consistent allocation to stocks and bonds—then, at some point in this bull market, you must sell stocks. I am hugely hesitant to do so, for three reasons. First, I am fundamentally a buy-and-hold forever investor, unless I need cash, so I don’t typically rebalance. Second, I hate paying taxes on stock gains in my taxable account. Third, I have no great ideas for what fixed-income alternatives I might buy, given today’s low interest rates.
After years of waffling as markets rose, I recently did something I’ve never done before: I sold a large chunk of index funds in my taxable account, despite not needing the money. Taxes drove my selection of what to sell—I sold holdings with the smallest percentage gains.
As many pundits point out, we don’t truly have profits until we sell. I took some profits and accept that I’ll pay the taxman his due. As an alternative, I could have locked in the gains and postponed taxes by buying a protective put. But puts require a cash outlay, timing considerations and trading complexities that aren’t for me.
I slightly offset these stock sales with stock purchases within my retirement accounts. Since I now have more cash in my taxable account, I can put off tapping my tax-deferred accounts for longer. The unplanned capital gains will also add to my adjusted gross income, likely leading me to reduce my planned year-end Roth conversions or my sales of my old employer’s stock.
Do I have a good plan for what to do with the cash I just raised? Not really. But for now, I am happy to live with today’s low yields. I have also structured my retirement accounts more defensively, shifting toward higher-dividend funds and stocks. If the stock market retreats, these stocks should be buoyed by their dividend payments, especially if the Federal Reserve lowers interest rates, as many anticipate.
In this low-interest-rate era, I have become a huge dividend aristocrat fan. Many pay yields of 3% to 4%, while offering low stock price volatility. I own shares of 20 such stocks—companies like Johnson & Johnson, McDonald’s and Procter & Gamble. They’re basically my only individual stocks. All pay continually increasing dividends. I have effectively accumulated my own dividend mutual fund without the annual fees. Performance has been as good as, or better than, my institutional dividend funds. What’s not to like?
To place a check on my inherent greed, I recently sold some covered calls at even higher strike prices for several of these appreciating aristocrats. This is another new defensive and somewhat bearish approach for me. If these aristocrats keep up their stunning price gains, I’ll sell out a portion at great returns and be automatically rebalanced. If not, I’ll pad my dividend income a bit more with the money earned from writing the covered calls. I’m great with either outcome.
Another possible defensive measure is to put in place stop-loss orders, which are a safeguard against market downturns. I haven’t implemented any stop-loss orders, but I’m watching the markets and they’re certainly an option to consider.
I may be totally wrong in selling some of my stock holdings. The market seems to have upward momentum. The Federal Reserve is set to lower short-term interest rates. But underlying fundamentals also seem weaker—which is why I finally took some money off the table.
John Yeigh is an engineer with an MBA in finance. He retired in 2017 after 40 years in the oil industry, where he helped negotiate financial details for multi-billion-dollar international projects. His previous articles include Take It or Leave It, Got You Covered and Nothing to Chance.
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Interesting John. I understand the selling to rebalance, but what was the reasoning behind buying more in the retirement accounts? I was confused until I noted you only slightly offset your sales, but still…
Hi John,
Enjoyed the post; I’m a fan too of writing covered calls if one’s meaning to sell stocks/ETFs to rebalance (why not make some option premium on top of it after all). In order to up the odds of exercise, I imagine you’d want write it at the current price and make money off the time value until expiration.
Same goes for trying to enter into a position — sell puts at the current price so up the odds of exercise and you, in effect, lower the entry point for that particular stock/ETF.
My one bit with your rebalance though is could you have kept everything in the taxable accounts as is to avoid realizing those gains and effect your rebalance in the tax-advantaged accounts only? I just did something like this myself though I understand it could be hindered by fund selection in your tax-advantaged accounts (not including IRAs).
Good advice. I assume you think owning individual high dividend stocks is better than owning an index fund composed of high dividend stocks. Which option do you recommend for the average investor?
I would also note that those of us who are over 70.5 can rebalance using our RMDs.
A dividend index fund would be better for most investors as they can set it and forget it – I do own these funds. Most of my wife’s and my retirement funds are in deferred tax accounts, and we have sufficient funds to allow a bit of playing around with individual stocks, so I personally am somewhat indifferent stocks vs funds – my aristocrats are all in some of the dividend funds. For even considering stocks, I suggest a bare minimum of perhaps $200K play money is needed which would allow $15K investment (1-300 shares) in 15 dividend aristocrat stocks minimum to develop reasonable diversification. I am in my mid 60’s so RMD’s are not an after-tax driver yet.
Hello John..
I’m 55 getting close to retirement (ETA 60-ish) so I have acute sensitivity to the state of my investments. So these days with people “trumpeting” a recession, I’m wondering whether I should do something. BUT Mr. Bogle says DO nothing ! Yet when I read posts like yours, I feel like i might have to DO something. Everytime I DO something, I usually regret later. SO, after reading your article, I’ve decided to DO nothing, but put in more future money toward more conservative investments to lower the overall risk of my portfolio