It's A Question Of Proper Balance

Do you tend to put off certain chores—maybe cleaning the gutters, organizing your files, or changing batteries in smoke detectors? Most people can add another item to their to-do list: rebalancing a portfolio. However, unlike neglecting some of the others, failing to rebalance could result in significant financial losses.

Why do you have to rebalance in the first place? If you keep your holdings intact without making any changes, your preferred asset allocation will eventually get out of kilter. As a result, you could be exposing yourself to considerably more risk than you expect or consider acceptable.

Let’s say you’ve determined the optional approach for your current needs is to maintain a portfolio with 50% allocated to stocks, 30% to bonds, and 20% to cash and other vehicles. (This is a purely hypothetical example and not indicative of any specific portfolio.) If the value of your stocks has increased during the past year, your portfolio might now have 75% in stocks, 15% in bonds, and 10% in cash and other investments. Stocks are historically more volatile than other assets, and with that heavier concentration, you may not feel comfortable with your risk exposure. To get back to your previous allocation, you could sell some shares and put the proceeds into bonds and cash.

Similarly, if the value of your stocks has declined so that they represent only 35% of your portfolio, you may want to convert some of your other holdings into stocks.

There are several other direct and indirect reasons for rebalancing. Consider these three:

  • It encourages you to cash in profits from investments that have done well and shift those funds to other investments that have merit but have yet to increase in value.
  • It gives you the opportunity to review the mutual funds in your portfolio to see whether they’re still performing up to your expectations.
  • It can smooth out investment returns. All asset classes are cyclical, so rebalancing removes some of the inherent volatility associated with investing.

How often should you rebalance? For many investors, it makes sense to do it twice a year to keep a portfolio on track. Certainly, you should rebalance at least once a year. Another approach is to rebalance whenever an asset class deviates from its target percentage by a specific amount—perhaps five percentage points. For example, a portfolio with a 50% target allocation in stocks would be rebalanced any time the value rises to 55% or sinks to 45%.

Rebalancing is an important part of long-term investment management. It ensures that you are buying asset classes when they drop in value and don’t overweight investments that have appreciated. Over a long period, it can make a major difference in a portfolio’s performance and risk exposure. In addition, rebalancing can be managed for tax efficiency. Our firm handles rebalancing for clients we work with.

This article was written by a professional financial journalist for G.W. Sherwold and is not intended as legal or investment advice.

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