How and When to Rebalance Your Portfolio

Rebalancing is the process of bringing the various asset classes of your portfolio back to their appropriate weight in order to meet investment and risk objectives. Investors rebalance their portfolios to maintain the mix of stocks, bonds and other assets that was outlined in their original investment plan. If any part of your investment objectives or risk tolerance has changes, the rebalancing process can be used to adjust the weight of each asset class to meet these newly defined requirements.

Issues with an Improperly Balanced Portfolio

Effective management of risk is the primary objective of portfolio rebalancing. Because past performance does not always indicate future performance, remaining heavily invested in assets that did well the previous year can leave investors overly exposed to losses in the future. By ensuring that your portfolio does not become overly dependent on any single asset class, you effectively control your risk and leverage the full benefits of diversification. Rebalancing enforces the “buy low, sell high” principal by regularly trimming back on the previous year’s winners and increasing your holdings in undervalued areas of the portfolio.

Don’t Rebalance Too Often

Because rebalancing requires that you sell off some winners, your taxable investments will be subject to capital gains tax. In order to minimize this cost and the labor associated with rebalancing, most financial experts believe that once a year is adequate.

Steps to Rebalancing Your Portfolio

(1) Collect the Data: Start by gathering the data for all of your individual accounts and combine them in order to consider your portfolio as a whole.

(2) Divide Your Holdings: Break down your holdings into the three major asset categories of stocks, bonds, and cash.

(3) Compare Current Holdings Against Objectives: When you know the current percentages of your holdings, you can make comparisons against your stated objectives. If your original plan called for 60% stocks, 40% bonds, and 10% cash and you’re currently holding 70% in stocks, your portfolio obviously needs some adjusting.

(4) Adjust: Sell the investments in which you’re currently over-weighted and reallocate the proceeds into under-weighted categories.

(5) Repeat the Process Annually

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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