The Rebalancing Mindset
You spent decades building a growth portfolio. VOO, QQQ, SCHG - assets that compound but don't pay much. Now you need to pivot to income without destroying your nest egg in taxes.
Common Mistake: The Big Bang Rebalance
Don't sell all your growth holdings in one year. If you have $500K in VOO with a $200K cost basis, selling it all triggers $300K in capital gains. At 15% long-term cap gains, that's $45K to the IRS.
The DivAgent Tier Allocation Framework
Your target allocation depends on your risk tolerance and income needs. Here are three model portfolios for pre-retirees.
Conservative (Low Risk, 4-5% Target Yield)
Portfolio Yield: ~4.5% • Weighted Tier: 2.2 • Volatility: Low
Best For: You have enough capital to hit your income needs at 4-5% yield. Preservation > growth.
Balanced (Medium Risk, 6-8% Target Yield)
Portfolio Yield: ~7% • Weighted Tier: 3.0 • Volatility: Medium
Best For: You need higher yield to close the income gap. Comfortable with monthly payment fluctuations.
Aggressive (High Risk, 9-12% Target Yield)
Portfolio Yield: ~10% • Weighted Tier: 4.0 • Volatility: High
Best For: You're significantly under-saved and need maximum yield. Accept NAV erosion risk.
Reality Check on Aggressive Portfolios
A 60% T4-T5 allocation might hit 10% yield, but NAV erosion will eat 3-5% annually in declining asset prices. Your real return is 5-7%, and you're carrying 3x the volatility of a balanced portfolio. This is NOT a set-it-and-forget-it strategy.
The 3-Year Transition Plan
Spread your rebalancing over 3 years to manage taxes and dollar-cost average into income positions.
Year 1 (5 Years to Retirement)
- Redirect new contributions: Stop buying growth ETFs. All new money goes to T2-T3 positions.
- Build the cash cushion: Shift 10% of portfolio to T1 (SGOV, BIL, money market).
- Harvest losses: If any growth positions are underwater, sell and swap to similar assets (VOO → IVV) to lock in tax losses.
- Start T3 positions: Add SCHD, DGRO, VIG to build dividend growth base.
Year 2 (4 Years to Retirement)
- Sell growth winners in low-income year: If you have a year with unusually low income (layoff, sabbatical), sell growth positions to stay in 0% or 15% cap gains bracket.
- Add T3 exposure: Begin positions in JEPI, O, ARCC, EPD.
- Max out tax-advantaged space: Contribute maximum to 401(k) and IRA to shelter income.
Year 3 (3 Years to Retirement)
- Finalize tier allocation: Target your chosen allocation (conservative/balanced/aggressive).
- Prune growth positions: Trim remaining VOO/QQQ down to 10-20% for some upside optionality.
- Add T4 if needed: If income gap remains, cautiously add JEPQ, QQQI, DIVO.
- Test-drive the income: Stop reinvesting dividends. Take distributions as cash to simulate retirement income.
Tax-Loss Harvesting Strategy
Market downturns are your friend during the transition. Use volatility to your advantage.
The Wash Sale Rule
You cannot sell an asset at a loss and buy a "substantially identical" security within 30 days before or after the sale. But you CAN swap to a similar-but-not-identical fund:
- VOO (S&P 500) → IVV (S&P 500): Same index, different issuer.
- QQQ (Nasdaq-100) → QQQM (Nasdaq-100): Same holdings, lower expense ratio.
- VTI (Total Market) → ITOT (Total Market): Maintains equity exposure.
Loss Stacking for Big Transitions
If you're sitting on $100K in unrealized gains in VOO, you can offset them with harvested losses:
- Sell $100K of underwater positions (e.g., ARKK down 40%).
- Book $40K in capital losses.
- Sell $100K of VOO (books $100K gain).
- Net taxable gain: $60K instead of $100K.
- Tax savings: $6,000 at 15% cap gains rate.
Account Placement Optimization
Where you hold assets matters just as much as what you hold. The wrong placement costs thousands in taxes every year.
Tax-Deferred Accounts (Traditional 401k/IRA)
Put here:
- T3-T5 high-yield assets (REITs, BDCs, covered call ETFs)
- Assets that pay non-qualified dividends (taxed at ordinary income rates)
Why: Shields high-income distributions from current taxation.
Tax-Free Accounts (Roth IRA/401k)
Put here:
- Your highest-growth potential assets (keep some QQQ/VOO)
- T5 speculative positions if you're aggressive
Why: Growth compounds tax-free forever. No RMDs to force withdrawals.
Taxable Brokerage
Put here:
- T2 dividend growth stocks (SCHD, VIG, individual aristocrats)
- Assets with qualified dividends (taxed at 0-20% vs. 10-37%)
Why: Most tax-efficient. Qualified dividends + long-term cap gains treatment.
Pro Tip: The Roth Conversion Ladder
If you retire before 59.5, convert chunks of Traditional IRA to Roth each year (up to the 12% or 22% tax bracket limit). After 5 years, those conversions become accessible penalty-free. Builds a tax-free income stream for your 60s.
Action Items
Choose Your Target Allocation
Pick conservative, balanced, or aggressive based on your income gap from Module 1.
Draft Your 3-Year Transition Plan
Map out which positions you'll sell each year and what you'll replace them with.
Redirect New Contributions
Starting this month, all new money goes to T2-T3 income positions. Stop buying growth.