by Archie M. Richards, Jr.
June 18, 2007

The more you fiddle with your investments, generally the worse the results. I've advised in these columns that you simply buy when you get the money and rebalance every year-and-a-day. Otherwise, forget about the portfolio and let the market do the work long term.

This hands-off approach remains valid if you're holding the investments in your own name (or the name of a living trust) and you're not adding to the portfolio or withdrawing from it on a regularly basis.

But if your investments are held in a tax-free environment, such as a traditional or Roth IRA, you could have slightly better results by rebalancing, say, six times a year.

You may download a spreadsheet without charge from the Suggested Portfolios section of this web site. The spreadsheet enables you to invest and rebalance. It calls for investment changes only if the market-value percentage of one or more of the investment sectors has risen by more than 20 percent from the desired percentage.

Rebalancing is an automatic method of selling high and buying low. If you're rebalancing only once a year, you might lose the chance to sell a portion of an investment sector whose percentage of the portfolio has risen by more than 20 percent but then slipped back into the pack before the year has passed. Rebalancing every two months might enable you to take advantage of those temporary moves.

But do this only in a tax-free environment. Otherwise, rebalance annually to avoid short-term capital gains.

I've said in these columns and in my book, "Understanding Exchange-Traded Funds," that the U.S. stock market since 1926 has compounded at 12 percent a year. This wasn't quite correct.

In his fine book, "Stocks for the Long Run," Professor Jeremy J. Siegel states that from 1926 to 1997, U.S. stocks gained at 12.6 percent a year, based on average earnings. But based on the more realistic compound earnings, the market gained only 10.6 percent a year.

I have projected that the portfolio recommended in my website will compound at 10 percent a year, pre-tax, in the next decade or two. I still think so. Improved economic policies and ever more sophisticated electronic equipment will cause worldwide stock prices to grow faster in the future than they have in the past. Compounding at 10 percent a year, pre-tax, is a reasonable guess.

Just don't sell when the news is bad. Doing so decimates long-term returns.

Dan writes, "Three years ago, I invested $5,000 in a mutual fund of real estate investment trusts. The fund has paid $6,500 in dividends and capital gains which were reinvested back into the fund. The adjusted cost basis is $11,500 ($5,000 plus $6,500).

"The fund is now worth $25,500. I need to sell some or all of the shares to pay for my daughter's wedding. My accountant tells me I won't have to pay capital gain tax because taxes have already been paid on the dividends and capital gains.

"But an advisor at the fund says I will have to pay capital gains tax on the difference between the $25,500 proceeds and the $11,500 adjusted cost basis. Which approach is correct?"

The advisor is correct, Dan. You pay capital gains on the difference between the sales proceeds and the adjusted cost. (I'm guessing that your accountant knows this, but didn't explained it clearly.)

Real estate investment trusts (REITs) have special tax considerations:

• A portion of each dividend is likely to be treated as a return of capital. That portion is not taxable and may not be added to the cost.

• REIT dividends are taxed as ordinary income. The rate is not capped at 15 percent, as is true for most stocks.

Finally, Dan asks, "If I sell only some of the shares, how should I report which shares were sold?"

Take your tax records to a service such as H&R Block, Dan. They'll know the story. To find the answer yourself, go to the IRS's web site and consult IRS Publication 550. All the best to your daughter.