How to Rebalance Your Portfolio

Rebalancing your portfolio is akin to building a solid house; it starts with establishing a strong foundation. Before you begin, it’s crucial to define your financial objectives, investment timeline, and risk tolerance. Based on this evaluation, you can outline a diversified asset mix that may include stock and bond exchange-traded funds (ETFs). You can do this with the help of a financial advisor, a robo-advisor, or through your own research.

Typically, younger investors tend to allocate a larger percentage of their portfolios to stocks, while those with a more conservative approach may prefer a greater proportion of bonds and cash investments. This guide will walk you through the essentials of rebalancing your portfolio, addressing key questions and providing a structured approach to the process.

The Purpose of Rebalancing

The primary goal of rebalancing is not to achieve perfection. As soon as you realign your investments to their target percentages, market prices will shift, leading to deviations in asset values. It’s advisable to rebalance your portfolio at least once a year and to consider the following factors:

• How much has my portfolio strayed from the original asset allocation?
• Am I still comfortable with my current asset mix, or do changes in my situation warrant adjustments?
• Have my financial goals or risk tolerance evolved?

Strategies for Rebalancing Your Portfolio

Several methods can be employed for effective rebalancing:

1. Set a Drift Tolerance: Choose a percentage range that triggers rebalancing, such as when an asset class deviates by 5% from its target weight. You can adjust this range based on your risk tolerance and the time you’re willing to dedicate to maintaining your asset allocation.
2. Schedule Regular Rebalancing: Rebalancing once a year is generally sufficient, though some investors prefer more frequent rebalancing (quarterly or biannually). Less frequent rebalancing may lead to higher stock allocations and potential for greater returns, albeit with increased volatility.
3. Add New Funds to Underweighted Assets: If certain assets have underperformed, consider adding new capital to these classes to restore your desired allocation.
4. Withdraw from Overweight Assets: If an asset class has grown beyond your target allocation, sell a portion of that asset to bring the allocation back in line. For example, if stocks have appreciated, you can sell some of your stock holdings and withdraw the proceeds.

Steps to Rebalance Your Portfolio

To effectively rebalance, follow these steps:

Step 1: Track Asset Allocation
Keep a detailed record of your portfolio’s asset allocation, which can be maintained using a spreadsheet or an investment tracking tool like Quicken or Mint.

Step 2: Analyze Current Allocation
Compare the current percentage of each asset class with your original targets. Tools like Quicken can help simplify this process.

Step 3: Identify Deviations
Determine how far your actual allocation has drifted from your preferred mix. For instance, if your target is 80% stocks and 20% bonds, but it has shifted to 85% stocks and 15% bonds, it’s time to rebalance.

Step 4: Execute Sales
If you need to sell 5% of your stock assets, calculate the amount based on your portfolio value. For example, with a $100,000 portfolio, if stocks should represent $80,000 but currently represent $85,000, you would sell $5,000 worth of stocks.

Step 5: Purchase Assets
With the proceeds from the stock sale, reinvest in bonds or other underweighted asset classes to restore your desired allocation.

Step 6: Invest New Money
When adding new funds, calculate the desired allocation for each asset class. For example, if you add $10,000 to a $100,000 portfolio, your total portfolio value would now be $110,000, requiring you to adjust your allocations accordingly.

Using Robo-Advisors for Rebalancing

For those who prefer a hands-off approach, a robo-advisor can be an excellent solution for portfolio management and rebalancing. Platforms like Wealthfront and Schwab Intelligent Portfolios offer diversified investment options, automated rebalancing, and features like tax-loss harvesting, often at lower fees. Typically, robo-advisors start with a survey to gauge your financial goals and risk tolerance, which then informs your investment strategy. After your investments are set up, these platforms will handle rebalancing as needed to maintain alignment with your original goals.

Pros and Cons of Portfolio Rebalancing

Managing your portfolio, including rebalancing, requires dedication. You’ll need to regularly evaluate your investments to ensure they align with your objectives. Here are some advantages and disadvantages to consider:

Pros:

• Reduces volatility and overall risk in your portfolio.
• Enhances diversification by maintaining your desired asset allocation.
• A structured rebalancing schedule can prevent panic selling during market downturns.

Cons:

• May reduce exposure to high-performing sectors while increasing investment in underperforming areas.
• Could conflict with tax-loss harvesting strategies.
• Requires a basic understanding of financial principles and active management.

Additional Tips for Successful Rebalancing

Rebalancing is just one aspect of investment management. Here are some additional tips:

• Limit Frequent Checks: Avoid checking your portfolio values too often to minimize the temptation to make impulsive trades.
• Create an Investment Policy Statement: Outline your asset allocation, rebalancing criteria, and investment strategies to stay disciplined.
• Minimize Tax Liabilities: In taxable accounts, consider tax-loss harvesting strategies to offset gains.
• Maintain a Long-Term Perspective: Stay focused on your long-term goals and avoid making hasty decisions based on short-term market fluctuations.

Conclusion: The Importance of Rebalancing

A balanced portfolio typically includes a mix of growth-oriented stocks and more stable bonds to help manage risk. Without regular rebalancing, an overconcentration in stocks during market upswings could lead to significant losses during downturns. Rebalancing ensures your investments remain aligned with your financial goals and helps you navigate the complexities of market fluctuations effectively.