Is it worth paying CGT to rebalance my portfolio?

Brendan Burgess

Brendan Burgess

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This article in the FT
FT article "Embrace the power of doing nothing"
raises an interesting point which I may not have paid enough attention to.

"It is far better to pay tax at the end of a long period of compounded gains rather than each year on small gains. By holding investments for long periods, be they stocks or property, these taxes are deferred and better compounded returns will be achieved."

I am a long-term buy and hold investor directly in around 10 shares.

But two years ago, because DCC had done very well, it had grown to 20% of my assets. So I sold half of them and reinvested the net proceeds after CGT in another share.

Let's say I sold €100 worth of shares. My gain was €70, so I paid €23 CGT.

I reinvested €77.

Would I have been better off just taking the risk of being overweight in DCC?

As I say, I am a long-term buy and hold investor. If I still own the shares when I die, the CGT liability will disappear, so I will have unnecessarily paid CGT.

I will sell some of my shares over the years to fund my retirement, and so the first shares I sell are the ones I am most overweight in.

So maybe I should wait until I need to sell shares, rather than actively re-balance my portfolio?

Brendan
 
Brendan Burgess said:
Would I have been better off just taking the risk of being overweight in DCC?
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I guess that it is ultimately a personal decision based on your own risk assessment/tax position. Personally, I would consider a 10 stock portfolio to be overly concentrated to begin with so it's really a question of degree.

One of the advantages of holding investments through a tax-deferred pension fund is that an investor can rebalance between asset classes without suffering any tax drag.
 
You'll only find out over time. Having one stock increasing from 10% to 20% of your overall portfolio is certainly increasing the level of risk in that one company. If DCC falls dramatically over the next few years, you will know it was worth selling off a portion and paying the tax.

But I would certainly say that 10% is enough differential to rebalance and pay the tax.


Steven
www.bluewaterfp.ie
 
I'm sure you've already considered it Brendan but you could balance up to the equivalent of the annual exemption each year, either way? I used this as a basis for my diversification in 2014 and 2015, together with realising Irish bank share losses, to move into other shares. I guess if you've already used up such losses (or more fortunately, never had them in the first place!) then the annual allowance mightn't cover too much of the gain.
 
I chatted with someone else about it and they reckoned that as CGT rates are more likely to fall than rise, it's probably not a good idea to rebalance the portfolio.

Brendan
 
Hi Brendan

Like you, I am a firm believer in a buy and hold strategy, but if I think a stock is overvalued, my first instinct is to sell; the CGT consequences are a secondary (but still important) consideration.

I wouldn’t sell just because a share represented over 20% of my portfolio, as seems to have been your motivation. As you know, I don’t believe in diversification. The top two stocks in my portfolio each have a weighting of over 20%. The top five account for over 83% of my total equity exposure (and I’m almost completely in equities). I don’t lose any sleep at night over that.

If you think stock A is overvalued, and are thinking of switching into stock B, which you think is more attractively priced, the sums are straightforward – in theory. The problem is that you must make heroic assumptions on expected future returns for both stocks. You must decide on an investment horizon, and project returns x% and y% for stocks A and B respectively over that period, allowing for CGT of €z to be paid if you sell stock A now. You must also allow for the fact that stock B may have a lower contingent CGT liability at the end of the period (assuming stock A is now at a significant premium to the original purchase price). To be honest, I’ve never done the sums. I’m inclined to work more on instinct, having calculated what the tax will be if I sell immediately and with a vague idea in my head of what the differential (y-x) is likely to be.

Like you, I also plan to sell a few shares every year to fund my retirement. I definitely won’t use the fact that I have a high weighting in a particular stock to decide if it’s a candidate for sale. The primary criterion is whether I still like the share. Secondary considerations are concentration and the overall balance of the portfolio, in terms of exposure to different geographies, markets, etc..

We should mention the €1,270 per annum that’s exempt from CGT, and the desirability of not letting it go to waste in any year, but it’s pitifully small, and hardly worth worrying about.
 
Thanks Colm

I don't believe that I have any ability to identify winning shares or losing shares. I thought that DCC was a fine share, it was just that I was significantly overweight in it. If it had been only 10% of my assets, I would not have sold.

I don't think that tax should drive such decisions, but they should be taken into account. I took an immediate 23% hit to achieve this diversification which is very heavy. I could have deferred it and maybe even avoided it by dying.

Brendan
 
Don't forget you can offset Capital Gains with Capital losses. So if you are sitting on any losses you should sell them too. You can immediately buy back into the shares you've just sold if you wish to continue to hold them.
Also remember that Ireland allows (a paltry) 1,270EUR of CGT free gains each year.

Ideally you could sell off 1270 of gains each year tax free to re-balance.
 
I also suspect that when people are rebalancing their portfolio to reduce the risk, it's not about saving €419.10 (€1,270 @33%)
 
AJAM said:
If you're a long term investor, Saving 419.10 p/a over 10 or 20 years is not insignificant.
Click to expand...

As I have pointed out. If someone is concerned that the growth in value of one share might be making the overall portfolio too risky, then it's unlikely that they are concerned with a gain or loss of €419.10.

That is not to say that someone should not avail of this exemption for other purposes, but not for de-risking a portfolio.

Brendan
 
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