Portfolio Rebalancing: How to Prioritize Tax Efficiency

Portfolio Rebalancing: How to Prioritize Tax Efficiency

Treating the household as a single portfolio can produce better tax results for clients.

Wealth Management Editor
Reviewed by: Kent Thune
Edited by: James Rubin

When it comes to the task of rebalancing client portfolios, financial advisor Chuck Failla believes there is the easy way and there is the best way. 

Failla, founder and chief executive of New York-based Sovereign Financial Group, has found that most turnkey asset management platforms opt for the easy way, which can save time but also trigger tax consequences for clients. For that reason, he launched his own platform for the 17 advisors at his firm managing nearly $800 million in client assets. 

In simple terms, Failla is fixated on the distinction between account level rebalancing and the more hands-on approach of portfolio group rebalancing that includes all accounts inside the same household. 

Failla’s portfolio group approach is particularly well-suited for advisors that lean into cashflow-based financial planning. His asset management platform evolved from his system of matching a household’s time-horizon-based cash flow needs with an asset allocation that best matches those needs. 

He has trademarked his system as TAMI for Time-Horizon Asset Management Integration. 

“It’s essentially a more systematic way of adopting a bucket strategy,” he said. 

Account level rebalancing is fine if there is only one account in the household. But that’s rare because most households include multiple taxable and tax-deferred accounts for each adult. 

Portfolio Rebalancing at the Household Level for Tax-Efficiency

For example, a married couple might each have a traditional tax-deferred IRA and a tax-exempt IRA for four total accounts. If the rebalancing goal is to bring each account to weightings of 60% stocks and 40% bonds, most portfolio management programs will just adjust each account. 

But, as Failla points out, treating the household as a single portfolio and rebalancing at that level can result in less trading activity and a better taxable experience for the clients. 

But it’s more work. 

“It’s more complicated and requires more human oversight,” Failla said. “If you’re doing account level rebalancing without any tax sensitivity, that’s easy.” 

Consider, for example, a married couple with four investment accounts between them. 

Each of the accounts has $250,000, and the $1 million combined total includes $800,000 in equities and $200,000 in bonds. 

A rebalance of the overall portfolio to represent 60% stocks and 40% bonds, requires the sale of $200,000 worth of equities. 

Failla’s system does that in a three-step process by first looking inside the taxable accounts for positions that can be sold at a loss for tax purposes. 

The next step is to sell equities out of tax-deferred accounts.  

And if he still hasn’t reached the goal of $200,000 worth of stock sales, Failla goes back to the taxable accounts to sell the stock positions with the highest-cost-basis for the lowest tax hit. 

Failla said tax management is considered throughout the rebalancing process and inevitably generates some tax consequences. 

“We have the advisor tell us what the client’s tax budget is, and the advisor and the client work with the trader to determine the next steps,” Failla said. “Now you have to make a decision.” 

From Failla’s perspective, there are three basic tax management moves. You can throw the tax budget out in the interest of a perfectly rebalanced portfolio, adjust the portfolio by using ETF proxies for some equity positions, or live with a slightly out of balance portfolio. 

“Neither decision is right or wrong, and that’s the value the advisor plays,” Failla said.  

Contact Jeff Benjamin at [email protected] and find him on X at @BenjiWriter

Jeff Benjamin is the wealth management editor at etf.com, responsible for coverage related to the financial planning industry. This includes writing, hosting podcasts, webinars, video interviews and presenting at in-person events.

Jeff is a veteran journalist with more than 30 years’ experience covering the financial markets. He has won more than two dozen national and regional awards for his reporting. He most recently worked as a senior columnist at InvestmentNews where he wrote about investment products and strategies, as well as the broader financial planning industry. Prior to that, Jeff worked as an analyst at Cerulli Associates where he researched and wrote reports on the alternative investments industry. Jeff also worked as a money management reporter at Dow Jones Newswires, where he covered the mutual fund industry.

Based in North Carolina, Jeff is a former Marine and has a bachelor’s degree in journalism from Central Michigan University.