Goals-Based Portfolio Theory

CHAPTER 8Taxes and Rebalancing

“Experience without theory is blind, but theory without experience is mere intellectual play.”

—Immanuel Kant

I will be the first to admit that a chapter on taxes and rebalancing sounds like a chapter I would skip were I reading this book. I have enough somnolence in my day. Unfortunately, this is where the rubber meets the road and the balancing act of an individual's tax situation, various goals and ethical constraints, the firm's capital market expectations, along with the practical constraints of our chosen investment universe all come together. This is the job, as it were. The other challenge for practitioners and theorists alike is that this is not a simple problem to solve. Putting all of this theory together is a complex task, and each practitioner will likely have her own approach. My objective here is not to lay out the right answer, but rather, to sketch a framework for thinking about the problem and present a potential solution.

In a perfect world, the solution to the rebalancing problem would be quite simple. However, in addition to the challenges posed by the individualization offered by the goals‐based framework, it is very common for potential investments to themselves have varied allocations to subcomponents. A firm building capital market expectations around economic sectors, for example, may have to account for Amazon.com's link to both the technology sector and its link to the consumer staples and consumer discretionary sectors. ...