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The V20 Portfolio #27: When To Rebalance

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read the last update here . Note: Current allocation and planned transactions are only available to premium subscribers . After a volatile week, the V20 Portfolio declined by 3.2% while the SPDR S&P 500 ETF (NYSEARCA: SPY ) declined by 1.2%. The underperformance can once again be attributed to the largest holding, Conn’s (NASDAQ: CONN ). When To “Average Down” Recently our cash balance has grown as a percentage of the overall portfolio, which can be primarily attributed to the decline in portfolio value as opposed to strategic shifts in allocation. As mentioned earlier, the biggest laggard is Conn’s. You may recall that the V20 Portfolio will continue to purchase shares of a company if fundamentals have not deteriorated, even if price has dropped. In 2016, we did exactly that. Conn’s position would have been 42% smaller had we not made any purchases in 2016. But as share price has continued to drop since the last transaction, I have not yet made any additional purchases for Conn’s, which is a part of the reason why cash allocation has swelled to one of the highest levels since the portfolio’s inception. Why did I make that decision? The truth is that I’ve been looking for the opportunity to “pull the trigger” so to speak. This relates to my rebalancing philosophy. There are many ways to rebalance, but I break them down to systematic and discretionary. The former style follows a predetermined method (e.g. once every quarter according to some specification). As you probably guessed already, the V20 Portfolio’s rebalancing method is discretionary. I believe that too many factors are shifting to warrant a systematic method. However, discretion does not imply randomness. The V20 Portfolio seeks to allocate more capital to stocks with the highest expected rate of return while accounting for the possibility of permanent capital loss . I believe that the smallest position in the portfolio right now, Dex Media, actually has the highest expected return; but due to the high risk of shareholders being wiped out in the restructuring deal, it is not prudent to allocate a significant amount of capital to the stock, no matter the expected return. Bringing the discussion back to the topic of rebalancing; a position essentially shifts between “no exposure” to “too much exposure” at any given time. However, there is no specific number associated with these two groups. Let’s suppose that the ideal allocation is 10% for a certain stock. Should you rebalance when it falls to 9.99%? Or what if it rises to 11%? There is no good answer. However, if we examine the extremes, the answer can become clearer. Using the same example, I don’t think anyone will disagree that rebalancing would be appropriate if the allocation falls to 1%, assuming no changes in fundamentals. There are also short-term considerations. While the focus should be long-term, short-term fluctuations are very real. Each time you place a trade, you are implying that prices shouldn’t go lower, or else you would have waited. This implication exists even if your investment horizon is long-term . There are numerous factors that could lead to sustained mispricing. For Conn’s, the general macro picture for retail has been soft and the credit division’s results may not improve for a while. Both of these factors could put more pressure on the stock, providing better opportunities to accumulate shares. In conclusion, there is no “perfect” time to rebalance. I believe that Conn’s current allocation remains large enough to capture the stock’s significant upside. The allocation could be larger, it could be smaller. However, one thing is certain: if shares continue to fall in the future, there is no doubt that more capital would be allocated to the position. Performance Since Inception Click to enlarge Disclosure: I am/we are long CONN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Tax Loss Harvesting And Wash Sales

Whenever you have significant losses in a taxable account, you should consider tax loss harvesting, selling those losses as a part of tax planning and then buying a placeholder security for 30 days. Capital losses can offset capital gains or can give you a capital loss which you can report on your tax return . Up to $3,000 of losses each year can be taken as a deduction to reduce ordinary income each year. Capital losses, which are not used in one year, can be carried forward indefinitely to be used in future years. The Internal Revenue Service (IRS) prohibits a taxpayer from claiming the loss on their taxes if they buy a substantially identical security within 30 days before or after the sale. Selling Apple (NASDAQ: AAPL ) stock on Monday and buying it back on Friday, for example, triggers the wash sale rules. In that case, the loss which you attempted to realize on Monday must be applied to the cost basis of the stock purchased on Friday, giving you none of the capital loss benefits. As an example, suppose you owned stock with a cost basis of $60 per share and sold it for a loss at $40 per share. The stock starts to move back up and you repurchase it too quickly at $50 per share. Instead of receiving a $20 per share realized capital loss, you would have to assume a cost basis on your new stock of $70 so that you have transferred the loss to your new purchase. Something similar happens when you purchase a stock on Monday and then try to sell an identical position for a loss on Friday. As an example, suppose you owned stock with a cost basis of $60 per share. On Monday, you purchase a similar position at a cost of $40 per share. Then the stock price rises to $50 per share. On Friday, you sell the first position for what is now a $10 per share loss. Instead of receiving a $10 per share realized capital loss, you would have to add that back to the cost basis of the stock purchased on Monday. Monday’s purchase would now have a cost basis of $50 per share and coincidentally be trading at $50 per share. The $10 unrealized gain would be negated by the $10 transferred loss from the wash sale. The computation of wash sale cost basis adjustments can be complex to follow. That being said, the stock of one company is not “substantially identical” to a stock in a different company, regardless of the two companies. However, contracts or options on a stock are considered substantially identical to the stock itself, and preferred stock which is convertible into common stock without any restrictions may also be considered substantially identical. To avoid the wash sale rules while still harvesting the gains, you could just wait the 30 days to buy the security back. However, when a position has a loss can be one of the worst times to miss being invested in it. Assuming it is part of a brilliant investment plan, you would like to realize the loss and still remain invested in it or something very similar to experience any rebound that may occur. There are several ways to remain invested in something which is very similar but not substantially identical. At Schwab, wash sales are computed automatically and cost basis adjusted for securities which have identical symbols. For securities which have different symbols, they assume that such investments are not substantially identical. Early on, we wrote an article on the fund selection choice between the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) and the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). Both are good choices and their returns are extremely highly correlated. While the investments are very similar, they are not substantially identical. They follow two different emerging markets indexes. The number of holdings differs by 177 stocks. One invests 14% in South Korea and the other one invests nothing. One expense ratio is over four times that of the other. While the IRS has never issued a ruling, I am comfortable stating that for any of these reasons the two funds are not “substantially identical.” The wash sale rules were written prior to the advent of mutual funds and exchange-traded funds and the IRS has never pursued investors for changing investments which have some overlap of underlying funds. For this reason, it is nice to have two different investments for each sector of your asset allocation. You can sell EEM for a tax loss and buy VWO the same day to remain invested in the sector. Investments which are similar enough to stay invested do not have to be as similar as EEM and VWO. Any fund with a relatively high correlation will help maintain investment returns for the 31-day wash sale waiting period. But what if you prefer one investment selection for a category above all the others? In this case, you have to wait 31 days between your buy and sell. You have two options. First, you could sell the original position for a loss and allow the proceeds to wait for 31 days out of the markets until you can buy back into the identical position. Or second, you can buy more of the position and have twice what you would normally have for 31 days before you sell the original position for a loss. Wash sale rules need to be followed when realizing capital losses for taxes. They can be burdensome to track and monitor when you are trading on your own and are therefore another way an investment advisor can add value to your portfolio management.