Is It Time to Rebalance Your Portfolio?
In the world of investing, a set-it-and-forget-it approach can be costly. Even if you've built a well-diversified portfolio, its components can drift out of alignment over time. This is why periodically reviewing your investment strategy and rebalancing your portfolio is one of the most important habits for long-term financial success.
What Is Portfolio Rebalancing?
Rebalancing is the process of adjusting the holdings in your portfolio to bring them back to their original target asset allocation. For example, if your plan is to maintain a 70% stock and 30% bond mix, market fluctuations might cause stocks to grow faster than bonds, shifting your allocation to 80% stocks and 20% bonds. Rebalancing means you would sell some of your stocks and use the proceeds to buy more bonds, restoring your portfolio to its intended ratio.
Why Rebalance?
The primary reason to rebalance is to manage risk. When a part of your portfolio performs exceptionally well, it naturally becomes a larger percentage of your total holdings. This might seem like a good thing, but it also increases your exposure to that single asset class. If that market segment then experiences a downturn, your portfolio would be hit harder than if it had been properly balanced. Rebalancing helps to systematically sell high and buy low, a core principle of successful investing.
How to Rebalance
There are two main approaches to rebalancing:
Time-Based Rebalancing: This is the simplest method. You set a specific time interval, such as every six or twelve months, to review your portfolio. On that day, you adjust your holdings as needed, regardless of market performance. This provides a disciplined, regular check-up for your investments.
Threshold-Based Rebalancing: This method is based on your asset allocation percentages. You set a tolerance band around your target allocation. For instance, if your target is 70% stocks, you might set a threshold of 5%. If your stock allocation rises above 75% or falls below 65%, you would rebalance. This approach is more reactive to market movements and may be more efficient in volatile markets.
A Practical Example
Let’s say you start with a $100,000 portfolio: $70,000 in stocks and $30,000 in bonds.
Year 1: Your stocks perform well and grow to $85,000, while your bonds only grow to $32,000. Your new portfolio value is $117,000, but your allocation is now approximately 73% stocks and 27% bonds.
Rebalance: To get back to your target 70/30 split, you would sell about $3,500 worth of stocks and buy $3,500 worth of bonds. This brings your portfolio back into alignment, ensuring you're not taking on more risk than you're comfortable with.
While rebalancing may seem counterintuitive—selling your winners and buying your laggards—it is a crucial discipline that forces you to lock in gains and stick to your long-term strategy. It's not about trying to time the market, but about maintaining the risk level you initially decided was right for you. Need some help rebalancing or determining your risk tolerance? Set up a free 30-minute consultation to see how Legs Financial can help.
