Whether new to financial literacy or simply brushing up on skills, you must consider rebalancing your portfolio. This practice keeps your investments working efficiently, making you more money and potentially helping you avoid certain risks.
Here we’ll guide you through the ins and outs of rebalancing your portfolio, including when you should do so, factors to consider, and what steps you’ll need to take to ensure it’s a worthwhile endeavor for you.
Understanding Investment Portfolio Rebalancing
Let’s break it down. Your portfolio contains your assets- stocks, bonds, cash, real estate, ETFs, cash alternatives, etc. These are all working for you as investments to grow your money.
You may hear the term “asset allocation” thrown around when discussing financial portfolios. Asset allocation is the concept of the initial balance you aim to achieve when creating your portfolio, diversifying the assets to manage the risk versus reward possibilities, and allocating certain funds according to what you value or want to see grow.
When you go to rebalance your portfolio, you’ll have to re-assess the “weight” of all of these in detail and how things could be restructured to put you in the best position.
Rebalancing them is critical because, over time, the value of these assets can be affected by anything from the market to the value of that particular asset (i.e., real estate) to an economic downturn- and beyond. The practice of rebalancing your investment portfolio helps you maintain your predefined risk profile through up and down markets.
Factors to Consider When Deciding Rebalancing Frequency
When it comes to timing, you’ll want to rebalance your portfolio based on a few specific factors, including:
- Risk tolerance and investment goals
- Time horizon
- Types of investments in the portfolio
- Market conditions and volatility
Let’s take a look at one of these factors: market volatility. You should know the market and stay current on fluctuations since they can directly impact your investments.
For example, if you were rebalancing in 2009 when the recession was in swing and the prices of stocks had fallen drastically, you would want to rebalance your portfolio to put more emphasis on stocks (while they are down) s and less weight on other investments, such as short-term bonds and cash that had performed better on a relative basis.. The act of rebalancing introduces a disciplined approach to investing, because the rules-based framework forces you to buy-low and sell-high. This practice is certainly easier said than done in the moment, but highly rewarding for your portfolio over the long-term.
Remember, finances don’t exist in a vacuum, so considering all the above-mentioned factors and working with a professional is essential when rebalancing your portfolio.
Common Rebalancing Strategies
Beyond timing, you can also use various strategies to balance your portfolio. They are:
This strategy involves rebalancing on a predetermined schedule, such as annually, semi-annually, or quarterly.
This strategy can be beneficial as the practice of rebalancing won’t fall by the wayside, as it’s guaranteed to be on your calendar and, ideally, scheduled as an appointment with your financial advisor. It will keep you updated on the market and finances and allow you to make necessary changes.
One potential drawback to this method is if the appointments are too far apart and a significant change in the market or your life happens, you don’t rebalance in time.
This strategy involves rebalancing when portfolio asset allocation deviates by a certain percentage from the target allocation. For example:
A 20% relative band on the same domestic bond allocation target would mean a rebalancing trigger of four percentage points above or below the target allocation (20% of the 20% bond allocation). Therefore, the portfolio would be rebalanced if that fund’s allocation goes above 24% or below 16%.
Another potential strategy is to rebalance if an asset class has drifted from its original target by an absolute percentage of 5% or a relative of 25%, whichever is less.
The percentage-based method can be beneficial for managing risk tolerance. One drawback might be that it’s not tied enough to following market trends and solely relies on set numbers and percentages rather than the big picture. You will also need to determine the appropriate percentage thresholds to set.
Hybrid rebalancing is a combination of calendar-based and percentage-based rebalancing. This is your best bet, as it keeps you on track with scheduled check-ins but still allows flexibility and adaptability.
Determining an Optimal Rebalancing Frequency
You’ll need to monitor and evaluate your portfolio performance to determine the optimal frequency for rebalancing your portfolio.
While it’s a good practice to consider, there can also be a trade-off between rebalancing costs and potential benefits.
Another factor to consider is the impact of transaction costs and tax implications.
Rebalancing with a multidimensional understanding of both taxes and asset class volatility is critical to understanding the e potential implications of shifting your assets around.
Guidelines for Rebalancing Frequency
More factors to consider when rebalancing are different types of risk profiles. As a reminder, risk profiles are the following:
- Conservative – This is often paired with a short time horizon. Someone with conservative risk-taking isn’t willing to take on many risks.
- Moderate – More likely to balance and rebalance and has a longer time horizon.
- Aggressive – This profile describes someone willing to take greater risk, even if it involves a more long-term time horizon.
Let’s look at a concrete example:
An investment you once considered low-risk and held 20 percent of your portfolio might turn risky in five years. Your weighting should then change to a lower amount to accommodate.
If you believe in the long-term value of certain investments and have a lengthy time horizon, then holding on might be a good idea. If you hold certain investments to maintain a low-risk profile, you’ll likely need to rebalance your portfolio to reflect market movements.
A financial advisor can help you to determine the best rebalancing frequency based on your risk profile.
Balance is Key
If you try rebalancing independently, you must stay informed about market conditions and investment trends. Rebalancing regularly and with the right strategy can help you get ahead no matter what the market is doing, reduce risk, and make the most of your investments. Set aside time to work with a professional to evaluate and rebalance your portfolio to achieve your financial goals. Book a complimentary call today to get started!
Craig Toberman is the Founder of Toberman Wealth – a fee-only, fiduciary financial advisor based in St. Louis. He assists families and businesses with strategic financial planning and long-term wealth management. He has over a decade of experience in financial services and has crafted custom financial plans for hundreds of families and businesses.
Craig received a Bachelor of Science (B.S.) degree in Agricultural and Consumer Economics from the University of Illinois and a Master of Business Administration (M.B.A.) degree in Finance from Saint Louis University. He is a Certified Financial Planner (CFP), Chartered Financial Analyst (CFA) charterholder, and Certified Public Accountant (CPA).
Craig is a member of the National Association of Personal Financial Advisors (NAPFA), Fee-Only Network, and XY Planning Network.
Craig lives in the greater St. Louis area with his wife, Ally and son, Hank.