A New Way to Rebalance Your Asset Allocation
Millions of Americans have simplified their Investments by choosing an asset allocation model based on age, risk tolerance, etc, with low-cost passive index funds used for each asset class. No matter which asset allocation you use, or the number of asset classes, most professionals recommend periodic rebalancing of the portfolio back to the desired asset allocation percentages. Equities have seen a huge run-up in the last couple of years, so in most cases, rebalancing requires the sale of some equity holdings and most likely the purchase of some fixed-income funds. At a time when equities are flying high and interest rates are near zero, selling equities to buy bonds is difficult for many investors. Of course, one of the keys to successful investing is the ability to put aside your emotions and strictly follow the rules of rebalancing periodically.
Rebalance by Donating Gains
If you hold Equity Funds in a taxable account, let me suggest an alternative to selling: Donate part of your appreciated equities to a Donor-advised fund (DAF). Donor-advised funds are the fastest-growing vehicle for charitable contributions, and there’s a good reason. When you transfer equities to the fund, you’ll get an immediate charitable deduction for the full value of the equities donated. But more importantly, you’ll escape paying taxes on the capital gains. If you’ve been holding stocks or ETFs in a taxable account for a few years, chances are a good percentage of the market value is unrealized capital gains. Uncle Sam can’t wait for you to sell those securities so he can cash in on your good fortune. So it’s important that you donate (transfer) the stock or fund shares rather than sell them and donate the cash. More about that later.
What is a Donor-Advised Fund?
A Donor-advised fund is registered as a 501c3 charity, so contributions to it are tax-deductible as a charitable contribution. The difference is that the contributions you make to the fund are held in a fund account until you determine when and where a grant should be made to a specific charity. You can request that the charitable fund make a grant to your favorite museum, church, or any 501c3 organization. Assuming that the fund agrees that the charity is legitimate, they will issue a check along with a nice cover letter to your charity. Of course, you will not get an additional charitable contribution deduction because you got a deduction when the equities went into the fund. We use the Schwab Charitable donor-advised fund, but similar funds are available at Fidelity, Vanguard, and elsewhere. Schwab lets you name your account to include your family name. So when they make a grant to a charity, it’s sent on a nice “Feil Family Charitable Fund” letterhead, which is a nice little ego boost. I feel like one of those rich guys you see listed in the credits of a PBS series.
Making the Donation
Transferring equities to a Donor-advised fund is much easier than you might think. Like most clients, my Schwab account consists of several sub-accounts; i.e. IRAs for myself and my wife, and a taxable account. The Schwab charitable account is added as an additional sub-account. You can simply transfer shares of an appreciated equity from your taxable account to the charitable account. If I have 500 shares of Vanguard Total stock market (VTI), I can transfer 50 of those shares to the charitable fund. If I log into my account a couple of days later. I’ll see that Schwab has accurately recalculated the cost basis for my remaining 450 shares, and I will see my donation appear in the charitable account. Here’s the interesting part… You can even manage the investments in the charitable account. Schwab has several pre-allocated investment pool funds, i.e. “Conservative”, “Growth”, etc., as well as a number of single asset class investment pools (both active and passive), i.e., “Total Market Equity”, “Income Index Fund”, “International Equity” and “Money Fund”. When you request that the fund issue a grant, you can identify which investment is sold. If you have a sizable charitable fund account with its own asset allocation, you may need to rebalance periodically. I would do this by requesting grants be made using the asset classes which have appreciated the most. Do you see a pattern here?
Donor-advised funds are also useful in tax planning strategies. If your taxable income varies from year to year, you can lump your contributions to get the largest tax benefit. Contribute to the fund in a year when your tax bracket is high. Then you can continue to request grants to charities when your tax bracket is low. Of course, if the whole point is helping people through charitable contributions, it doesn’t make sense to have assets sitting idle in a charitable account year after year.
Here are some items you may want to consider when choosing a Donor-advised fund.
- What are the minimum contribution amounts?
- What are the minimum Grant amounts?
- What kind of Investments pools are available for the account assets?
- Is it easy to transfer a select number of shares from your taxable account to the charitable account?
- Does the fund let you Name the account? i.e., “The Harvey and Wilma Schmidt Wildlife Fund”.
- If you have a specific favorite charity in mind, it would be important to make sure that the fund recognizes the charity as legitimate. Most funds have databases with thousands of recognized charities, but if you want to grant to a small charity or a local church, you may want to do a little research. Keep in mind that the contributions you make to the fund are irrevocable. Even though you can manage the money and invest in different asset classes, you will never get that money back.
So what are you waiting for? Rebalance your portfolio, get a tax deduction, and help a charity… all at the same time. It’s a WIN-WIN-WIN !