When you get new tires, they’re balanced and properly aligned to keep your car driving straight and smooth toward your destination. But over time, some tires may eventually wear unevenly and cause problems. Rebalancing helps you course correct back to how the tires performed when they were first installed — and the same is true for your investments. As the market changes, certain assets may become more heavily weighted in your portfolio than others, exposing you to greater risk. Rebalancing or reviewing and adjusting the allocation of assets within your investment portfolio helps keep it in alignment with your financial goals and overall risk tolerance.
Why Rebalance?
Suppose you have a 60-40 portfolio, meaning 60% of your investments are in stocks and 40% are in bonds. If, after a banner year, one of your tech funds has performed exceptionally well, your previously balanced 60-40 portfolio could now be skewed more toward stocks. And while the tech fund may be delivering robust returns now, that higher proportion of stocks (let’s say it’s now a 70-30 mix) is giving you increased exposure to the market and, therefore, presents a higher level of overall risk. To help mitigate risk and realign with your original 60-40 investment strategy, you might need to rebalance by trimming back your stock holdings and redistributing those funds into other asset classes.
Rebalancing isn’t focused on timing the market or scoring quick wins — it’s all about maintaining long-term stability. It helps keep high-risk assets from comprising an outsized portion of your portfolio when they grow. Though “set it and forget it” investing can be tempting, neglecting to periodically rebalance your portfolio can keep it from achieving your long-term goals.
How Often Should I Rebalance?
After a big shift in the economy or market, it can be a good idea to review your portfolio and see if it could benefit from some adjustments. If any of your more volatile investments now comprise a significantly increased or decreased proportion of your portfolio, it may be time to rebalance.
Relatively stable economies don’t always guarantee even-handed performance of all your investments. So even if major market-moving events haven’t caused you to rethink your allocations, rebalancing on a schedule can still be beneficial. Even an annual review can make a big difference in the long-term health and stability of your portfolio. However, the ideal frequency should depend on the individual investor’s circumstances, taking into account transaction costs, tax implications and personal risk tolerance.
What Are My Options?
Rebalancing may be an active and collaborative process, where you and a Financial Professional make decisions directly about your portfolio. However, target date funds (TDFs) can also be a great way to account for market shifts without as much involvement required on your part. A TDF automatically rebalances based on a specific glide path that typically becomes more conservative as the target date (usually retirement) approaches.
Other Considerations
While periodic rebalancing is a long-term strategy, it can have some short-term consequences you should bear in mind. Selling or purchasing assets can come with transaction costs, so make sure you’re aware of them before you make any changes.
And for some assets, you may incur capital gains taxes. Capital gains tax rates are calculated based on your filing status, the worth of the assets being sold and how long you’ve owned them. It’s essential to understand all the expenses associated with adjusting your portfolio before you rebalance and to factor that information into your decision-making process.
How Can I Start?
When you’re thinking of rebalancing, keep your goals in mind before reviewing your portfolio. With the help of a Financial Professional, you can find a strategy that best suits risk tolerance and investment goals while taking into account market changes. Like a rebalanced tire, a rebalanced portfolio can help ensure occasional bumps in the road don’t throw you off course.
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