27 Oct Should I use ‘stop’ orders for my portfolio?

Q. I have a question about using “stop orders” for my stocks and ETFs. I always had them set at 10% and when COVID hit, almost everything sold. It’s okay and I was able to buy them back at lower prices, but I got hit with capital gain taxes and ended up paying $92,000 combined to the IRS and the state. Ouch! Do you agree with using “stop orders” and do you think 10% loss is a good number to set them at? I’m 66, retired and nobody feels sorry for me. If you have those kinds of gains it’s not like you’re in a bread line. I just hate giving money to the government. Plus, my Medicare premiums will probably go up because of the extra income.
— Investor

A. Let’s start with an overall chat with your portfolio before we talk about a stop order, which will automatically sell an investment if it goes down by a certain percentage or to a certain price.

The right answer for you will depend on how you look at your portfolio.

Marnie Hards, a certified financial planner with Aznar Financial Advisors in Morris Plains, said she believes the wisest approach to investing is to build a well-diversified, low-cost, tax efficient portfolio and allow it to grow — and possibly decline temporarily — with the market.

She suggests you start by picking an overall asset allocation that you are comfortable with.

One example would be to invest 60% of your portfolio in equities and 40% in fixed income, ideally in a variety of sub-asset classes, she said.

For example, to maximize your risk-adjusted rate of return, you may want to invest in domestic as well as international companies of varying sizes, she said. You may also want to invest in a variety of fixed income instruments, such as short-term and intermediate term bonds, corporate bonds, foreign bonds and more, she said.

“Once you have established your portfolio, you should periodically — perhaps annually — review the overall asset allocation to ensure that your portfolio is still as aggressive or conservative as you intended it to be,” she said.

For example, she said, if the stock market has done very well since you originally established your target asset allocation, it is possible that your 60% equity/40% fixed income allocation has slowly become 70% equity/30% fixed income. This is a good opportunity to rebalance your portfolio back to target which essentially forces you to sell high and buy low to revert back to your original asset allocation, she said.

If you like the idea of using stop orders and being more hands-on with your portfolio, Hards suggests you do it in a separate account with a fairly small percentage of your overall portfolio.

As you personally experienced, this strategy can result in unanticipated capital gains, she said.

As you noted, it can also result in an especially high-income year that may result in IRMAA, the Medicare income-related monthly adjustment amount that occurs when your income exceeds certain levels.

“It sounds like you were smart enough to reinvest the money and get the benefit of the upswing of the market following the significant decline when COVID hit, but another potential downside to stop orders is that you do not reinvest the money and miss out on the subsequent rise of the market,” she said.

Good luck reassessing your portfolio.

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This story was originally published on Oct. 27, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.