This is an oft ignored question: should your asset allocation be affected by the amounts of the unrealized capital gains in your position. Let me give an example. Assume for simplicity you want 70% stocks and 30% cash.
Case 1: you have $10,000 of cash to invest. You pretty clearly put 7K in stocks and 3K in cash.
Case 2: you invested in stocks many years ago and they have done well. You have large unrealized, capital gains in your stocks and they are now worth 10X their original investment, namely $7K. If you were to sell all your stocks, you would be taxed and would be left with a siginificantly smaller sum. Or you can just sell enough stock to bring your allocation in line with the 70-30 allocation.
A coworker had asked this a few years back and I came to the pleasantly simple conclusion:
No, you should safely ignore all this and allocate oblivious to unrealized gains.
The short summary (which I need to elaborate on later) is that by considering the incremental return-risk tradeoff of a given allocation, the behaviour of your investments is blind to how much unrealized capital gain there is. Thus you invest blind to this. Thank goodness.
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