Smart Moves to Fix Your Portfolio

A lot of investors have taken a look at their portfolios during the past year and realized that they've made huge mistakes that cost them a lot of money. Whether you've hired a financial planner to advise you on what changes to consider, or you're tackling the problem on your own, you may find that you need to make some big moves to get your investments back into shape.

Yet before you simply chuck everything you own and start over, think twice. A rash decision could have a huge impact on your portfolio -- and you may end up making a bad situation even worse.

Digging in the dirt
When you're just getting started with your investing, putting together a new portfolio from scratch simplifies things a lot. All you have to do is pick which investments interest you, and decide how much to invest in each of them. You don't have to worry about what to do with stocks you already own. There couldn't be a cleaner way to begin your investing experience.

But let's face it: Most people don't just have a wad of cash sitting out there waiting to get invested. It's far more likely that you have a bunch of investments in your portfolio already -- and you probably aren't happy with a lot of them, especially if you're thinking about making big changes. Compared with the clean job of investing cold hard cash, figuring out what to do with existing investments and how to move your money around forces you to get your hands dirty.

None of these complications, though, is an excuse to avoid the job. Just be aware of some potential problems.

The tax bite
Even if you're convinced that the stocks in your portfolio aren't going to recover from their losses of the past couple of years, you still may be sitting on capital gains if you've held them for a long time. As an example, if you bought shares of these stocks five years ago, you'd have a potential capital gain if you decided to sell, even despite the fact that they've all lost 20% or more of their value since late 2007:

Source: Yahoo! Finance. Tax assumes 15% maximum capital gains rate applies.

Granted, all of these stocks have lost money over the past two years, and in some cases, those losses have been fairly substantial. But even if you've decided that you have too much risk in your portfolio, and you're looking to cut back on your stock exposure, you need to realize that you may be giving yourself a big tax bill next April.

If you own other stocks with losses, you can solve the problem by selling them along with some of your winners to cancel out gains and losses. If you're fortunate enough not to have big losers, then there's an argument to stretch out your stock sales over several tax years. Yet if tax rates go up in the coming years -- and recent indications suggest that's a fair possibility for those in high tax brackets -- then you may actually be better off taking the hit now.

Bad timing
Another argument favoring more gradual adjustments to your portfolio is that timing doesn't play such an important role. For instance, if you decide to cut your stock exposure from 80% to 50% all at once, then where your stocks happen to trade on that one day makes a huge difference to your future wealth. If you pick the wrong day to sell out -- or miss the best day to buy in -- then you could end up costing yourself thousands over time.

But if you decide to space out the switch over six to 12 months, then you're less vulnerable to short-term market movements. Obviously, if markets fall over that time, then you would've been better off selling everything at the beginning. But the gradual approach reduces the luck factor -- both positive and negative -- in favor of a longer-term average.

Be smart
If you've decided you need to make major changes to your portfolio, congratulations -- you've made one of the toughest decisions an investor ever has to make. If you take care to avoid pitfalls, you'll likely find yourself back on the road to wealth sooner than you think.