Your Advisor Rebalanced Your Portfolio. Congratulations. You Owe Taxes.

Every portfolio drifts. Markets move, asset classes diverge, and the allocation you started with stops being the allocation you have. Rebalancing – the act of selling what has grown too large and buying what has shrunk – is how you bring it back. It is basic portfolio hygiene. Nobody disputes this.

What most people do not realize is that every time their advisor rebalances, they may be handing a portion of their returns directly to the IRS. In California, that portion can be substantial.

The Expensive Way Most Advisors Do It

The standard approach is simple: your equity allocation drifts above target, so you sell equities and buy bonds. Clean. Logical. And if those equities have appreciated – which they almost certainly have if they drifted above target – you just realized a taxable gain.

Do this annually in a taxable account at California's top combined rate and you are giving up over 50 cents of every dollar of gain to taxes before you even think about reinvesting. Not once. Every time you rebalance.

The Tax-Aware Way

Tax-aware rebalancing is not complicated. It is just a different order of operations.

First, use new contributions to rebalance. If your equity allocation is too high, direct new cash into bonds instead of selling equities. No sale, no gain, no tax. The portfolio moves toward target without a taxable event.

Second, rebalance across accounts, not within them. Sell the overweight position inside your IRA where there is no capital gains tax. Buy the underweight position in your taxable account. Same net effect, zero tax cost.

Third, pair gains with losses. If you must sell an appreciated position in a taxable account, offset it with harvested losses from elsewhere in the portfolio. The gain is real. The tax bill does not have to be.

Fourth, let drift run a little longer in taxable accounts. A portfolio that is 63% equity when the target is 60% is not an emergency. The cost of rebalancing it immediately may exceed the benefit of being precisely on target.

The Bigger Picture

Rebalancing is not a single decision. It is a recurring one. Done thoughtlessly, the tax cost compounds year after year. Done carefully, it barely registers.

At STQ, every rebalancing decision goes through a tax lens first. We ask what the after-tax cost of the trade is before we make it – because a portfolio that is perfectly allocated but perpetually generating unnecessary tax bills is not well managed. It is just tidy.