Anyone serious about growing their finances can’t deny the benefits of investing money.
Picking the right, diversified mix of stocks, bonds, mutual and exchange-traded funds, and other assets is a stronger money maker than your average savings account.
Investing is by and large a passive source of income, so it’s easy to run the risk of “setting and forgetting” a portfolio, trusting that your original investments will always harness the same earning power.
Investments, by nature, are designed to be dynamic, to fluctuate with the ups and downs of changing market conditions.
That means over time, an investment portfolio that once made you a lot of money becomes a bit stale, failing to perform as well as it used to -- and you might even lose money instead of earning it.
Frequently rebalancing your portfolio can help avoid this problem and keep your investments fresh and continually meeting your goals. Just as the stock market and financial climate changes, so should your investment portfolio.
The Reason for Rebalancing
Think of your investments like a diet and fitness regimen. What might have worked for you 5 or 10 years ago might not be as effective today.
To maximize results, you need to go back, revisit your plan, revise it, tweak it, and recalibrate it to meet your needs today.
Now, think of your investments portfolio with the same rationale.
For example, assume you opened your portfolio with a 50 percent allocation to stocks, 30 percent to bonds, and 20 percent to other assorted index funds.
Over time, or sometimes, even for a month here or there, stock prices rise, and now you’re allocating 65 or 70 percent to stocks by year’s end, at the expense of your bond and index fund allocations.
In essence, rebalancing enables you to take funds earned from one stock and allocate them to stronger stocks with a chance of increasing in value.
Or, maybe some of your investments have been underperforming, and it’s time to reassess what to sell, and which new investments to buy, to get back on track.
But then, what if the stock market is in great shape, and your investments increase in value, along with your stock allocation?
That’s not necessarily a problem in itself, per se, but it makes your investments more vulnerable to losses should there ever be a downturn on Wall Street.
In this case, rebalancing diversifies your portfolio and prevents it from running the risk of losses due to a stock market dip (or worse, a crash) -- either by redirecting your allocations to another investment, or selling off certain investments and buying brand new ones.
Your investment levels -- everything from stocks to currency and cash values -- are mostly at the mercy of those market highs and lows, which is why frequent, regular rebalancing is a must even when your portfolio is in good shape.
It’s like that fitness program or your car; even if you and your vehicle might be in the best shape of your life, it’s still important to check in every so often to see if there’s anything that needs adjusting.
It protects your allocation levels from getting out of whack, keeps your goals on target, and helps identify new goals to set.
When to Rebalance
If you have a healthy combination of investments, be it individual stocks and bonds, or grouped into a retirement fund, rebalancing your portfolio about two times annually keeps you in touch with your assets, your allocations, and the status of your investments.
Experts recommend a once-a-year rebalancing for mutual funds.
How often you rebalance, however, really depends on the number of investments you have, how sensitive they are to the market, and the current volatility (or lack thereof) of the market.
For instance, it’s not very common for the stock market to see such extreme upswings and downswings that would affect your portfolio in a major way.
Financial experts maintain that your allocations, in any given time frame, won’t deviate more than three or four percentage points, and at the most, a five-point threshold, in any given direction.
Keeping this in mind, don’t feel forced to rebalance your portfolio if the differences in market and investment values are negligible to you. But do keep track of your investments regularly to best gauge when you should rebalance.
If portfolio rebalancing is something you’d rather do at set times of the year, mark your calendar so you don’t forget, and use important dates, like birthdays, holidays or anniversaries.
Some investors choose to rebalance around tax filing time, in April, or in December, tax loss harvesting time.
Of course, rebalancing on an as-needed basis is a smart move that doesn’t compel you to tweak with your portfolio just because the calendar tells you so.
It’s hard to predict exactly when stocks will rise or fall, but say you check in and find some of your allocations have dropped in value; this presents a chance to buy more at a cheaper price.
Likewise, seek out stocks that have potential to rise in value.
How to Rebalance Your Portfolio
Whether you handpicked your investments yourself or used a financial advisor’s expertise, developing a rebalancing strategy for your portfolio is simple:
1. Set allocation target goals
Setting the right balance of asset allocations for your various investments varies from person to person, and depends on all sorts of factors, like your income, your age, your projected age of retirement, and the types of assets you invest in.
With that, you might try the “110 Rule” if you can’t get a fix on the right numbers. Take the number 110 and subtract your age; the answer is how much you should put into stocks.
So, if you’re 30 years old, 80 percent of your asset allocation towards equity-based stocks is a good starting number. For bonds, currency, mutual funds, and others divide up the remaining 20 percent.
This isn’t a hard and fast rule, but it can help you get your portfolio on track no matter your age, or the stage you’re at in your career.
Additionally, there are a number of risk calculators and other asset allocation tests available online to find your perfect allocation target.
2. Take stock of your investments
No pun intended -- portfolio rebalancing isn’t possible without knowing where your investments are located.
You may know your allocations for that group of stocks and bonds you bought early this year, but are you forgetting any other retirement accounts, like 401(k)s, or an IRA that’s been overlooked?
Most importantly, how much are you allocated for said investments? You’ll need to know where you stand currently before any changes can come ahead.
Or, in other words, buy and sell the investments that will bring you closer to your allocation goal.
Consider a hypothetical 60/40 split between stocks and bonds that you’d like to rebalance to 75/25.
If your stock goal is 75 percent of your allocations, but you currently have 60 percent toward equities, you’ll need to buy 15 percent in shares to meet that number.
Part of rebalancing is how that move affects your other investments. With the purchase of new stocks, you’d need to sell 15 percent in bonds to reduce your allocations to 25 percent.
One strategy that can help guide you along is called the tolerance band method: here, you’d set a maximum percentage allocation change according to stock market fluctuations, and change accordingly.
So, if you’d allow for a market fluctuation up to 3 percent, you’d rebalance only after your allocation passes that threshold.
Investing using online software or an assortment of banking apps means you can also automatically rebalance your portfolio without needing to tediously, manually crunch the numbers one at a time.
Target-date funds are mutual funds that automatically rebalanced as time goes on, with the goal of reaching a target amount at a target date.
They aim to maintain a certain asset allocation based on your risk tolerance and retirement date.
Over the years, these funds will rebalance to ensure the asset allocation isn't absolutely deviating from your risk tolerance.
Part of a robo-advisor’s self-guided, autonomous structure is that yours will not only pick investments, and buy and sell, but the automatic rebalancing of your portfolio is part of its account management structure.
Beware being driven by emotions or investing too much in that stock that’s touted as the next big thing.
By investing conservatively and pragmatically, you’ll compile an investment portfolio that’s got potential for building wealth and keeping you on target for reaching your financial goals.
Remember that rebalancing isn’t separate from investing. It is investing -- the process of fine-tuning and honing your allocations for maximum financial effect.
How you rebalance, and what you allocate, should change as time goes on. Your financial goals also can, and will, change, too, whether it’s changing jobs, starting a family, or adjusting your retirement date.
By keeping a close eye on your investments and rebalancing as needed, your investments will help you reach those goals with money in the bank.