Portfolio advice, unsure if rebalancing and realizing gains is needed

[vanquy3009]

Context: 36M/F with 2 kids 4 and 1. Got an inheritance in 2022 that was a mix of bonds and mutual funds. I sold the bonds and put in index funds but still have a bunch of mutual funds trading at high unrealized gains. Not sure if my allocation and is ok. Based in NYC so taxes on capital gains are pretty substantial when taking account state and local tax on top of federal.

High level allocation:
65% US Equity, 25% Developed Markets Equity, 10% Emerging Markets Equity

US equity is nearly all in VTI/VOO/VXB but about 5pt of the portfolio are in legacy positions of some mutual funds that are trading at high gains (about 3x cost basis).

The developed and emerging markets positions are about half VEA/VXUS/VWO which have low gains the other half some legacy mutual fund positions that are about 2x their cost basis and expense ratios between 0.25-1%.

Questions:
1. Is general split between US, Intl, and Emerging Market equities ok?
2. When is it reasonable to sell off mutual funds that have high unrealized gains but material expense ratios (0.5-1%)?
Any other input/observations is appreciated.

 

[purdella]

@vanquy3009 Assuming these holdings are entirely in a taxable brokerage account? If so, unless you need the funds right now for some reason I would rebalance the portfolio by changing where the funds going in are allocated over time vs. taking a tax hit now just to reposition. To your questions:

1) I think the split of equity seems fine, but if that’s the whole portfolio then I would think about adding fixed income at age 36.

2) Example: say you have a $50,000 capital gain that you’re considering realizing. Ignoring any NY taxes, assume $7,500 (15%) of fed taxes are owed (potentially $10,000/20% depending on your income). Even at the high end of your expense ratios (1%) you owe only $500/year on the amount you’re considering realizing. I personally would not take a $7.5-10k tax hit now to avoid $500/year in management fees (once you consider state taxes on top of that it’s an even easier decision). Invest in cheaper funds going forward, there are tons of options out there under 20bps

 

[vanquy3009]

@purdella Thanks. Yes, the gains are all in taxable accounts. This reply was helpful, much appreciated.

 

[donica]

@vanquy3009 The capital gains may not be as much as you think.

With the inheritance you get a step up in basis, explained here:

https://www.investopedia.com/terms/s/stepupinbasis.asp#:\~:text=Step-up%20in%20basis%2C%20or%20stepped-up%20basis%2C%20is%20what,taxes%20owed%20if%20the%20asset%20is%20sold%20later.

Here is some further background:

https://www.investopedia.com/ask/answers/073115/how-cost-basis-calculated-inherited-asset.asp

In short, your basis in the inheritance is the value when you inherited it, not what was the original owner paid for the shares.

The idea is the value at death is included in the decedent's estate, so the value to you is "reset" to market value.

I suspect if you apply these rules your potential capital gain will be lower, and therefore your taxes will be lower, making it less painful to reposition.

Good luck.