Rebalancing Your Investment Portfolio
Rebalancing your investment portfolio is a crucial strategy for maintaining your desired asset allocation and managing risk over time. It involves periodically buying or selling assets to bring your portfolio back to its original target allocation. This process helps you stay aligned with your financial goals and risk tolerance, especially as market conditions and individual asset performance fluctuate.
Why Rebalance?
Over time, the performance of different asset classes within your portfolio will vary. For example, if stocks have performed exceptionally well, they might grow to represent a larger percentage of your portfolio than you initially intended. Conversely, underperforming assets might shrink. Rebalancing corrects these deviations, ensuring your portfolio's risk and return profile remains consistent with your long-term objectives.
Rebalancing aligns your portfolio with your original investment strategy.
Market movements can cause your asset allocation to drift from your target. Rebalancing brings it back in line.
Imagine you start with a portfolio split 60% stocks and 40% bonds. If stocks surge 20% and bonds stay flat, your portfolio might become 70% stocks and 30% bonds. This increased stock exposure might mean higher risk than you're comfortable with. Rebalancing would involve selling some stocks and buying bonds to return to the 60/40 split.
Methods of Rebalancing
| Method | Description | Pros | Cons |
|---|---|---|---|
| Calendar Rebalancing | Adjusting your portfolio at set intervals (e.g., annually, semi-annually). | Simple to implement, disciplined approach. | May miss opportunities or rebalance at inopportune times. |
| Threshold Rebalancing | Adjusting when an asset class deviates from its target allocation by a predetermined percentage (e.g., 5%). | More responsive to market changes, potentially more efficient. | Requires more frequent monitoring, can lead to more frequent trading. |
The Rebalancing Process
The core of rebalancing involves comparing your current asset allocation to your target allocation. If there's a significant difference, you'll take action. This typically means selling assets that have grown beyond their target percentage and using the proceeds to buy assets that have fallen below their target percentage. Alternatively, you can rebalance by directing new investment contributions towards underperforming asset classes.
Rebalancing is a form of 'buy low, sell high' discipline, automatically encouraging you to trim winners and add to laggards.
Considerations for Rebalancing
When deciding how often and how to rebalance, consider transaction costs, taxes, and your personal circumstances. Frequent trading can incur fees and potentially trigger capital gains taxes. Therefore, a balance between maintaining your target allocation and minimizing these costs is essential. Many investors find that annual or semi-annual rebalancing, or rebalancing based on a significant drift (threshold), strikes a good balance.
Calendar rebalancing and threshold rebalancing.
Understanding and implementing portfolio rebalancing is a cornerstone of disciplined investing. It's a proactive strategy that helps manage risk and keep your investments aligned with your long-term financial journey.
Learning Resources
This Investopedia article provides a comprehensive overview of portfolio rebalancing, its importance, and different methods.
NerdWallet offers practical advice on how to rebalance your portfolio, including when and how often to do it.
Charles Schwab explains why rebalancing is a vital part of a successful investment strategy and how it helps manage risk.
Fidelity provides a clear, step-by-step guide to understanding and executing portfolio rebalancing.
Vanguard discusses the timing of rebalancing, covering both calendar-based and threshold-based approaches.
Forbes Advisor breaks down the concept of portfolio rebalancing, including its benefits and potential drawbacks.
Morningstar delves into the nuances of rebalancing, offering insights for investors to refine their strategies.
Bankrate offers a practical guide to rebalancing, covering the 'why' and 'how' for individual investors.
The U.S. Securities and Exchange Commission (SEC) provides investor guidance on asset allocation and the importance of rebalancing.
This guide from Canaccord Genuity offers practical steps and considerations for effectively rebalancing your investment portfolio.