The market’s natural ups and downs don’t just mess with your head; they also play with your portfolio and alter your asset allocation. That's why you should consider regular portfolio rebalancing as a recurring step in your long-term investment strategy.
Portfolio rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original allocation percentage.
Let’s back up even further for a second: One of the first steps you might consider when investing
is to determine the asset allocation appropriate for your particular financial goals. For example, let’s say you’re shooting for a well-funded retirement that’s set to start in 35 years. Given that long timeframe, and your personal comfort level with volatility, you decide to take an aggressive investing approach and go with an asset allocation of 90-percent stocks and 10-percent bonds for your retirement portfolio.
But because the market can move around so much each day, that allocation is bound to change over time, if left alone. So to maintain the status quo (or breakdown) of your portfolio, you may need to take action. And that action is what we call portfolio rebalancing.
Essentially, it works by buying and selling investments, as necessary, to recapture the initial asset allocation you wanted (assuming your investment objectives, time horizon and risk tolerance have remained the same).
Continuing with our example from above, let’s say your portfolio has ridden the bull these past few years to a current allocation of 95-percent stocks and 5-percent bonds. In order to rebalance back to a 90-10 split, you’d need to sell some of your stocks and buy more bonds to regain your original portfolio weighting.
That’s why automatic rebalancing can be so helpful. A number of investments and brokers offer this service to their investors. Target-date funds, for example, are designed to focus on hitting their investment goals in their respective selected years and automatically rebalance their portfolios in order to do so.
At Acorns, we do it, too. We determine an asset allocation for you, based on your income, age, time horizon, risk tolerance, and goals. Then, we automatically rebalance your portfolio to maintain that carefully chosen allocation. When you add money to your account, we distribute it across all the exchange-traded funds (or ETFs) you own in your portfolio to keep your asset balance steady. And when we review your investments, which is typically done on a quarterly basis, if any holding has moved significantly away from its initial weighting in your portfolio, we buy and sell ETF shares for you, as necessary, to get you back to your original allocation.
If you opt to manage it all yourself, you can rebalance your portfolio whenever you need to. Some experts recommend checking in at least annually; others suggest doing it more frequently, like every six months or every quarter. Just keep in mind that rebalancing more often could cost you more in trading fees and taxes, depending on your account type, broker, and particular action.
Another strategy: Rather than scheduling your potential investments based on a calendar, you can try rebalancing whenever your portfolio has strayed a certain amount away from your original allocation. For example, you may want to rebalance whenever your allocation drifts by 5 percentage points or more. So, following our first example above, now that stocks have grown from 90 percent to 95 percent of your portfolio, it’d be time to rebalance.
Doing it this way, though, could require a high level of portfolio monitoring. Your investment account may offer the option to set an alert once your allocation moves a specified amount. Otherwise, you just have to keep an eye on your portfolio yourself. Or you can base when you check your portfolio on the overall market. For example, if Standard & Poor’s 500-stock index (a collection of large U.S. stocks that’s often used as a benchmark representing the whole U.S. stock market) drops by, say, 5 percent, that could be a signal for you to look in on how your own portfolio is holding up.
And remember to dive deep into asset categories when checking your allocations. For example, if large, tech-focused companies in the U.S. have done particularly well, they may be taking up a much larger share of your portfolio now than you’d originally intended. So when you rebalance your portfolio, you may want to sell off those specific holdings rather than just any old stock holdings in order to maintain the diversification you want.
Also, you ought to rebalance whenever your goals change. For example, as you reach the final approach into retirement, your asset allocation should shift accordingly, likely into a more conservative stance. Furthermore, you may want to check and rebalance your portfolio more often at that point because once you’re on a fixed income and more reliant on your investment portfolio, it may become extra important for you to stick closely with your chosen asset allocation and limit your risk.
The time of year that’s best for rebalancing depends on what type of account you’re talking about. With a tax-advantaged retirement account, it typically doesn’t matter when you rebalance. But in a taxable investment account, keep in mind that there may be tax implications associated with your trading activity.
Let’s look back to our example: If your carefully constructed portfolio of 90-percent stocks and 10-percent bonds morphs into an allocation of 95-percent stocks and 5-percent bonds, that means your aggressive strategy has intensified, your risk has grown, and your cushion for safety has shrunk. So if and when stocks take a turn, your portfolio is now unfortunately positioned to take on greater losses than you’d originally prepared for and your long-term investment strategy could be set back.
Don’t let the market grind you down. You are in control of your own financial future. Yes, the market can take you for a wild ride based on any number of factors outside of your control. But you decide when, how much and how you invest by selecting your asset allocation and rebalancing your portfolio to stick with your long-term strategy.
Investing involves risk, including the loss of principal. This content is for educational purposes only and is not intended as financial advice. The views expressed are generalized and may not be appropriate for all investors. No investment strategy and no level of diversification or asset allocation can ensure profits or guarantee against losses. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. Contributors are not affiliated with Acorns Advisers, LLC. and do not provide investment advice to Acorns’ clients. Investment advisory services offered by Acorns Advisers, LLC (Acorns), an SEC-registered investment advisor. Brokerage services are provided to clients of Acorns by Acorns Securities, LLC, an SEC-registered broker-dealer and member FINRA/SIPC.
This material has been presented for informational and educational purposes only. The views expressed in the articles above are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses. Article contributors are not affiliated with Acorns Advisers, LLC. and do not provide investment advice to Acorns’ clients. Acorns is not engaged in rendering tax, legal or accounting advice. Please consult a qualified professional for this type of service.