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 regular rebalancing needs to be a recurring step in your long-term investing strategy.
What is rebalancing exactly?
Rebalancing is a key money move that helps ensure you stay the boss of your investment portfolio.
Let’s back up even further for a second: One of the first steps you need to take in 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 need to take action. And that action is what we call rebalancing.
How does rebalancing work?
Essentially, it works by buying and selling investments, as necessary, to recapture the initial asset allocation you wanted (assuming your preferences and needs have stayed the same).
In today’s market, the long-running bull has taken stocks to ever higher heights, most probably pushing your portfolio into a far heavier stock weighting than you’d prefer. 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.
That can be easier said than done. After all, your stock picks are winning! How could you sell them?! What if they keep winning?! Welp, friends, as counterintuitive as it may seem, that’s the game. It’s not about holding onto your winners until they turn into losers. It’s about achieving your financial goals for the ultimate win. But we know it can definitely be tough focusing on that final destination and ignoring all the distractions of the journey.
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 help you determine the right 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.
When should I rebalance my portfolio?
If you opt to manage it all yourself, you can rebalance 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 money moves 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, 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 you’ll need to pay taxes on any gains you make when you sell shares.
Why is it important to rebalance my portfolio?
For one thing, rebalancing your portfolio helps prompt you to buy low and sell high, an important tenet of successful investing.
For another, 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 is set back, off course.
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—and all of that ultimately helps determine your investing success, no matter what the market does.
Investing involves risk including loss of principal. This information is presented for educational purposes only and is not a recommendation to buy or sell a specific security or engage in a particular strategy.