Rebalancing your portfolio helps you stay on track to reach your investment goals. What happens is that after determining and setting your original asset allocation in correlation to your investment timeline, short- and long-term goals, and risk capacity/tolerance, certain assets begin to outgrow their original allocation in your portfolio.
balanced vs imbalanced portfolio
For example, suppose you have an asset allocation of 60% stocks, 20% bonds, and 20% international stocks in a portfolio worth $300,000.
That breaks down to:
- $180,000 in domestic stocks
- $60,000 in bonds
- $60,000 in international stocks
You have a well-diversified portfolio with such an arrangement.
But then stock prices slump and bond prices rise at equal rates (just for simplicity’s sake).
Now your portfolio looks something like this:
- $140,000 in domestic stocks
- $100,000 in bonds
- $60,000 in international stocks
You suddenly have a portfolio that is at odds with your previous asset allocation strategy. Now, this doesn’t mean that you should rebalance every day or even every quarter. After all, stocks may rebound and bonds may drop the next day – you never know. Plus, if you rebalance too often, you’ll rack up fees that will dig a hole into your portfolio’s value.
When should we rebalance an investment portfolio?
Portfolios need balancing to stay in line with shifting risk tolerances and investment timelines as you near retirement. Your portfolio should become more and more conservative over time – for example, you may want to move away from an aggressive 60% stock/20% bond /20% international stock allocation to a 40/40/20 allocation, and then eventually to a 20/70/10 allocation to help protect your portfolio from volatility as you near or enter retirement.
Besides the shift to more conservative allocations, there are certain strategies for short-term rebalancing. You can utilize a calendar-based approach by rebalancing monthly, quarterly, or annually. It’s important not to rebalance too often to keep costs low and prevent your emotions from taking over your decision-making processes. Another strategy is to rebalance once asset allocation proportions have strayed by a certain percentage, say, 5%.
Another issue is how to rebalance your portfolio.
You can either sell a portion of assets and reinvest those funds into the lacking asset. Using our previous example, if bonds are occupying 33% of your portfolio when they are supposed to be taking 20%, and domestic stocks are taking up only 47% of your portfolio, you simply sell 13% of your bond holdings and purchase stock funds to equal things out.
Another way is to use cash to purchase assets to equal things through dollar-cost-averaging. Instead of selling 13% of your bond assets, you purchase the necessary amount of stocks or international stocks to make things even. Perhaps you can’t make up for the disparity with one deposit, but you can choose what asset allocation to put into to help make up for it.
Buy Low, Sell High!
Besides helping you stay the course, portfolio rebalancing has an interesting side effect – it FORCES you to buy low and sell high. If you only ever BUY stocks or bonds when they are worth LESS than the other assets in your portfolio, and you only ever SELL stocks or bonds when they are worth MORE than the other assets in your portfolio, you are already doing something most performance chasers can never do. You’re BEATING the market!
At the same time, you’re not spending hours upon hours poring over charts and graphs, trying to determine if a company’s stock price correlates to its intrinsic value or if a company’s fundamentals value shows promising growth. You don’t have time for that!
Consistent fixed-dollar deposits spread across your portfolio will also help you fight market volatility through dollar-cost averaging and bring the overall cost of your purchased assets closer to the mean cost over a given period of time.
Diversify and Stay the Course!
A diversified portfolio of mutual funds, ETFs, and bonds, of both the domestic and international variety, coupled with low fees and consistent utilization of portfolio rebalancing and dollar-cost averaging strategies are the keys to investing success.
In Conclusion
Of course, there are other things that need to be carefully considered when investing – taxes, for example.
Fortunately, we are both tax and investment professionals, so we can offer you the best advice possible when it comes to your retirement planning. Click the button below to schedule a meeting and discuss your portfolio.
