- Balancing guarantees that, in line with your risk tolerance and objectives, your portfolio is varied among several asset kinds, including equities and bonds.
- It also entails making sure no one asset rules your portfolio and avoiding overindulgence in any one stock or investment.
- Rebalancing is the process of changing your portfolio to over time keep your chosen risk level.
- Individual investments vary with the times, which causes your portfolio to stray from its starting mix. Should stock prices rise, for example, stocks may account for more of your portfolio.
- You can rebalance either on a regular basis or if specific portfolio allocation thresholds are exceeded.
- Either selling investments to buy others or adding more money to particular asset classes, such as stocks or bonds, helps one to balance.
Using these techniques, why are these steps so important and what is the goal of rebalancing your portfolio?
Let’s explore these fundamental concerns more closely.
Why is balancing and rebalancing a portfolio so important?
The goal of balancing a financial portfolio is to get the right mix of risk and return from your investments.
You “allocate” your assets when you first come up with a financial plan and decide to put money into it. To make things easier to understand, let’s say you want 70% of your money to be in stocks and 30% in bonds. This is how you would originally fund your portfolio, and it would be what you call a balanced portfolio.
It’s a problem that these parts of your stock don’t always stay the same. Say that in five years, the value of the stock market doubles but the value of your bonds stays the same. If you do the maths, this would give you an allocation of about 82% stocks and 18% bonds, which is very out of line for your investments.
To keep your portfolio balanced over time, you can and should rebalance your financial account. If you put 70% of your money into stocks because you were willing to take on some risk, then your rebalanced portfolio should also have 70% stocks.
A Balancing Act
One of my past clients once said that her main goal when investing was to “maximize my return while minimizing my risk.” This is the most important thing to know about business. It would have been just as helpful for her to say, “I want to make good investments.” There will never be a single portfolio mix that works best for everyone because people are different in their age, income, net worth, desire to build wealth, spending habits, risk aversion, number of children, hometown with a certain cost of living, and a million other ways.
Still, general advice that can help people in certain life situations match their risk tolerances is out there. People over 50 who invest like they are in their 20s might not get the annual income they need, and parents who invest like they are single are common. But every year, they’re stealing huge returns from themselves.
How to rebalance your portfolio
Rebalancing your portfolio means moving your investments around so that they stay in line with your goal asset allocation. To put it simply, you sell some assets and use the money to buy others, making sure that your portfolio has the right mix of stocks, bonds, and other assets.
For example, if you find that your stock holdings have gotten too large for your risk tolerance, you could sell some stocks and put the money from the sale into bonds. This would bring your portfolio back in line with your risk tolerance.
Rebalancing can be done in two main ways:
Sell existing investments: To find the right mix, you should sell some of your better-performing assets and use the money to invest in areas that aren’t as well-known, like bonds.
Strategically spend new money: Instead of selling off assets you already have, you can put new money into areas that need more attention. To bring your portfolio back into balance, you could put new money into other stocks or assets if one stock has gotten too big.
A lot of investors like the second choice because it lets them keep their good investments while slowly changing their portfolio. This way also keeps you from selling assets that are doing well, which can be bad if they keep doing well. This approach might not always work, though, especially if you have limits on how much you can put into an account, like in an IRA or 401(k).
Rebalancing may be done for you immediately if you use a robo-advisor or are in a company-sponsored retirement plan.
One big advantage of portfolio rebalancing for long-term investors
When the value of an asset drops, our gut tells us to sell it before things get worse. Also, we want to put our money in the market when prices seem to be going up and “everyone” is making money. This is how people normally act, but it is the exact opposite of buying low and selling high.
When you rebalance your stock, you have to sell high and buy low. This is one of the most important reasons to keep your stock balanced over time.
For instance, if the stock market crashes and stocks lose 30% of their value, it’s possible that you have too many bonds in your portfolio. To get your portfolio back in order, you might need to sell some of your bonds and buy stocks while they’re still cheap. Setting up a balanced portfolio and taking steps to keep it that way can help you make smart investment decisions without letting your feelings get in the way.
Ways to Rebalance Your Portfolio
There are a few strategies for rebalancing your portfolio, each catering to different investor preferences and goals:
- Set a deviation threshold: Choose a percentage range at which to rebalance, such as when an asset class deviates by 5% from its target weight. The deviation range can vary from as low as 1–2% to higher than 5%, depending on how much risk the investor is willing to tolerate and how much time they are willing to spend managing the portfolio.
- Rebalance on a set schedule: Some investors rebalance on an annual basis, while others prefer to do so quarterly or biannually. The ideal strategy depends on the investor’s preferences and goals. Less frequent rebalancing may result in higher stock allocations and, potentially, higher returns, but it could also lead to greater portfolio volatility.
- Invest new funds strategically: Instead of selling assets, investors can use new money to rebalance the portfolio. This method involves adding funds to the underrepresented asset classes to bring the portfolio back to its target allocation.
- Use withdrawals to adjust weight: If an asset class has become overweight, such as stocks increasing by 1%, you can reduce its weight by selling a portion of the stocks and withdrawing the proceeds. This helps maintain the original balance of the portfolio while adjusting for asset growth.
How Often Should I Rebalance My Portfolio?
An excessive amount of rebalancing can result in a loss of returns. Increasing the frequency of rebalancing can boost returns while simultaneously increasing portfolio volatility. If the values of your portfolio deviate from the target by five percent or more, Vanguard suggests rebalancing your portfolio and monitoring it every six months.2.It is not possible to find a perfect method for balance. Setting up a rebalancing plan that is suitable for you, establishing a reminder for yourself, and sticking to it are the most important steps.
Read also: What are the Top 5 Stock Market Indicators?