Portfolio rebalancing is like detoxing periodically to ensure you are in optimal health. Rebalancing your investment portfolio is an opportunity to not only restore your asset allocation to its original balance but also add some juice to your portfolio returns.
When you established your investment portfolio, you determined the optimal asset allocation to meet your investment objectives. As the prices of the stock, bond, commodities and other investment assets in your portfolio fluctuate daily, your asset allocation changes. Over time, these daily fluctuations can substantially change the risk profile of your investment portfolio. A young, growth investor may have had 60% in equities, 30% in bonds and 10% in cash in the summer. Following China’s Black Monday in August, his equity stake may have fallen to 40 and bond stake increased to 50. This new asset allocation will deliver significantly lower returns over the long term, and may prevent him from reaching his retirement savings goals.
How to Rebalance Your Portfolio
You can rebalance your portfolio by buying and selling assets once a quarter, or as necessary, to re-establish the original asset weighting. At the time of rebalancing, you will want to consider the following:
Your risk tolerance – Review your risk profile. Your risk tolerance may have changed and it may be prudent to change your asset allocation at this time.
Costs – How much will it cost you in fees to rebalance your portfolio? Rebalancing too often or at the wrong time can generate high fees that erode your investment returns.
Taxes – The more you trade, the higher the amount of taxable income you can generate. Consider the tax implications of buying and selling securities. Reinvesting dividends or using new cash may be more efficient ways of rebalancing your asset allocation.
Calendar rebalancing is an efficient way of rebalancing and maintaining steady performance returns. Choose a time interval to rebalance your portfolio. For example, you may decide to tune up your portfolio every quarter or once a year.
Asset class rebalancing is conducted when the original weighting of assets in your portfolio is off balance. This is a type of tactical balancing that is engaged in in response to market movements. As part of your investment tactics, you may have a strategy set out for when to exit the market.
Generally, investors enjoy better performance when they follow a consistent periodic routine for buying and selling assets. Calendar rebalancing applies the same principle as dollar cost averaging. The risk of buying and selling at the wrong times is reduced when emotion and personal intuition are removed from investing.
Glide path rebalancing is the strategy employed by target-date funds. As an investor approaches retirement age, the portfolio’s weighting in equity is reduced and the weighting in bonds increased. This is an automated portfolio adjustment. Following extreme market movements, it may also be necessary to manually adjust the portfolio from time to time.
Rebalance Your Portfolio: Invest in the Winners
When rebalancing your portfolio, sell losing investments and re-invest in winning investments. In the above scenario, you may have money in emerging market exchange-traded bond funds (ETFs), which have done poorly since the August downturn. You may choose to sell these bonds and invest in large cap equity ETFs, which are doing well in the current market. By using calendar rebalancing, you will have avoided acquiring excess fees buying and selling securities immediately following Black Monday. Since the stock market decline, stocks have regained much of their value.
Sell your losers is a famous investment truism, and advice we have used in this article. Like any general rule of thumb, it should be used with caution. An understanding of cyclical investing can help you avoid selling stocks that are about to rise, and investing more in winning stocks that are on the verge of a steep decline. Like the economy, industries have cycles of peaks and troughs. Understanding when an industry cycle is at a low or high will help you avoid unnecessary trading in your investment portfolio.
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