How to Rebalance Your Portfolio Rebalancing is the process of periodically buying and selling investments in a portfolio to keep the asset allocation aligned with an investor’s risk tolerance and investment objectives.
What Is Rebalancing?
The goal of rebalancing is to counteract market movements, prevent any one asset or asset class from getting too large in your portfolio, and keep the asset mix aligned with your objectives and preferences.
Good practice is for investors to adjust their holdings annually. This article provides an overview of everything investors need to know about rebalancing.
How to Rebalance Your Portfolio
When you rebalance your portfolio, consider these questions:
- How far has my portfolio strayed from my original asset allocation?
- Do I still like my original asset allocation, or has my situation changed enough that I need to change the mix?
- Have my goals or my risk tolerance changed? If yes, has my allocation been adjusted for these?
- Is my current asset allocation really right for me? Is a change even needed for my portfolio?
Ways to Rebalance Your Portfolio
There are several rebalancing strategies:
- Pick a percentage range at which to rebalance—for example, when each asset class is 5% away from its target allocation. The window for drift tolerance can be 1%, 2%, or 5% or higher. The actual quantity will depend on your tolerance and how much time you are ready to spend to keep the portfolio compatible with the desired allocation.
- Set a rebalancing time. Most investors find that rebalancing once a year is enough, but some prefer to rebalance quarterly or twice a year. There is no right or wrong technique; less frequent rebalancing will likely lead to higher stock allocations and higher total returns, along with greater volatility.
- Add new money to the underweighted asset class to restore the portfolio to its original allocation.
- Use withdrawals to reduce the asset’s weight. If stocks are up 1%, sell some of the overweight positions and take the money off the table.
Steps to Rebalance Your Portfolio
It’s good practice to keep track of important changes to your portfolio. You can save your data in a spreadsheet or use a free or commercial portfolio management tool such as Quicken or Sharesight.
Once you have identified your assets and computed the percentage weightings, you can rebalance as necessary.
Step 1: Compare
Compare the current asset values and the weight percentages for each asset class with your established (or newly desired) asset allocation.
Step 2: Assess
See how your current asset allocation stacks up to the one you’d want. If your 80% stock, 20% bond portfolio has moved to 85% stocks, 15% bonds, it’s time to rebalance by either investing fresh money in bonds or selling stocks and buying bonds.
Step 3: Sell
Let’s say you have a portfolio of $100,000. With the above drift and 80%/20% balance in mind, you’ll sell $5,000 of stock investments to bring your percentage of stocks down by 5%.
Step 4: Buy
Now you can buy $5,000 of bonds using the $5,000 proceeds from the sale of the shares. That will get your portfolio back to the 80%/20% mix you like.
Step 5: Add Funds
Let’s imagine you want to put $10,000 into your portfolio. Now it would be worth $110,000, and the targeted 80%/20% asset mix would require $88,000 in equities and $22,000 in bonds.
(To get at these cash objective levels, multiply $110,000 by 80% for the stock allocation and multiply $110,000 by 20% for the bond allocation).
Step 6: Invest New Funds
Remember, you now have $85,000 in stocks and $15,000 in bonds. To get to the ideal 80/20 equity/bond split (meaning $88,000 in stocks and $22,000 in bonds), you’d add another $3,000 in stocks and $7,000 in bonds.
How to Use a Robo-Advisor to Rebalance Your Portfolio
How to Rebalance Your Portfolio
If you want to hand off the selection and rebalancing of your portfolio, a robo-advisor can be a good option.
Wealthfront and Schwab Intelligent Portfolios are examples of robo-advisors that offer investors access to diverse portfolios, rebalancing, and other features such as tax-loss harvesting at minimal or no cost.
How to Rebalance Your Portfolio The most popular robo-advisors will have you fill out a brief form to establish your financial goals, timeline, and risk tolerance. The makeup of your investment portfolio is affected by this survey.
After you’ve invested, robo-advisors will automatically rebalance your assets as needed to stay within the original survey boundaries.
Pros and Cons of Portfolio Rebalancing
Rebalancing is an effort in investment management. You will need to monitor your investments closely to ensure they continue to meet your objectives.
If you’re comfortable taking on more risk, you can choose to increase the stock allocation. Or if you’re approaching retirement or uncomfortable with double-digit drops in the value of your portfolio from time to time, you may want to boost the fixed income allocation to protect capital.
Additional Tips to Rebalance Your Portfolio
Here are additional tips to aid in rebalancing:
- If you didn’t when you first constructed your portfolio, write a personal investment policy statement (or investment plan) that describes your investment mix, asset allocation, and rebalancing criteria. Hold on to it.
- 1. Minimize taxable events from taxable accounts. This includes tax-loss harvesting (selling losing investments to offset capital gains).
- Maintain a bif picture perspective to achieve your long-term objectives. Do not be deceived by fluctuations in the value of your assets.
Remember, the purpose of investing is to transform your current income into future financial stability.
Rebalance and Invest . This is the way to grow your returns over a long period, perhaps 10 or more years. For shorter-term goals, consider a certificate of deposit or a high-yield money market account.
Why Should I Rebalance My Portfolio?
You need to rebalance your portfolio regularly to ensure your assets (e.g., stocks and fixed-income instruments) continue to align with your financial objectives and risk profile. Asset values change; therefore, the asset weights in your portfolio might vary. If you don’t rebalance and bring your assets back to the predetermined balance, say, of an 80%/20% stock/bond mix, you might be exposing yourself to more risk than you’re comfortable with. Rebalancing keeps your investments aligned with your financial objectives.
How Much Does It Cost to Rebalance a Portfolio?
Most investment brokers don’t charge commissions or trading fees for stocks and ETFs, so it’s usually cost-free to buy and sell stocks and funds. You probably pay a fee to acquire or sell bonds if you own them directly. Mutual funds may charge a trading fee.
If you are buying and selling stocks or ETFs, the only expense you might have is a tax on a capital gain if it is realized in a taxable brokerage account.
Can I Rebalance My Portfolio Without Selling?
Yes, you may rebalance your portfolio without selling any positions. “Put fresh money into the portfolio and buy the underweight asset class. If you need to withdraw cash from your account, sell some of the over-represented asset. You may also reinvest cash dividends in an underweight asset class.
Does Portfolio Rebalancing Reduce Returns?
Rebalancing often diminishes returns. Without rebalancing, stocks will comprise a larger share of the portfolio over time, since they have historically delivered higher returns than bonds. When you rebalance, you will sell some stocks, which will reduce your portfolio’s return. But remember, stocks are riskier than bonds; the more stocks you have in your portfolio, the more risk you have. Rebalancing recovers the tradeoff of higher return and reduced risk.
How Often Should I Rebalance My Portfolio?
Rebalancing too often may erode profits, while rebalancing too seldom can raise portfolio risk. Vanguard suggests reviewing your portfolio yearly. The trick is to set and stick to a rebalancing timetable that works for you.
The Bottom Line
Rebalancing smooths your portfolio’s volatility and maintains your chosen asset allocation.
If stock prices are rising, rebalancing will mean taking some gains. And that is when prices are lower, and an asset class is down in value: you will have a chance to acquire at lower levels.
You may save time by rebalancing less often and letting your winning assets run a little longer.