The Most Important Thing You're Probably Not Doing With Your Portfolio

Life changes, and so do financial markets. That's why it's important to periodically examine whether your portfolio still reflects your financial goals. "Rebalancing" is simply the process of bringing your portfolio's assets back to their original, planned percentage-mix of investment types. The reason for this is that some investments appreciate, while others depreciate over time, creating a different balance than you may have intended.

Why Rebalance?

One investing rule of thumb is that stock and bond prices move in opposite directions. Let's say you're 35, and allocate 65% of your portfolio to stocks and 15% to bonds. The economy is moving along nicely and you have a good year in the stock market and by the end of it, stocks represent 75% of your portfolio. This asset mix is out of alignment with your goals! To bring it back into balance, you will need to sell the over-weighted asset (stocks in this case), and purchase the under-weighted asset — bonds. This realigns your portfolio with your investment objectives.

How Often, How Far, and How Much: How Frequently Should You Rebalance?

There are three rebalancing strategies. How often you choose depends on whether you're still saving and re-investing the dividends, or retired and taking withdrawals.

Time Strategy

For a systematic approach, investors can follow the time-table strategy. This can be daily, monthly, quarterly, yearly, or whatever works. With this approach, it will not matter how far away your assets deviate from your goals. The only variable impacting your rebalancing decision is time. Of course, which frequency you choose should be determined based on your time horizon, risk tolerance, diversification strategy, and the costs to rebalance.

But the average investor doesn't have the time nor resources for a daily — or even monthly — rebalancing strategy, and most of us choose less frequent rebalancing..

Threshold Strategy

With the threshold strategy, the one thing that will trigger a rebalance is deviation away from your target goals by a definitive amount, say 3%, 5%, or 10%. Deciding on this strategy could require daily, monthly, or quarterly rebalancing, or it may be that you won't need to rebalance for five, 10, or 15 years. Again, your investment goals should help you determine whether this strategy is appropriate for you.

Hybrid: Time and Threshold

Here, both the time and threshold strategies guide your decision to rebalance.

You will rebalance your portfolio on a periodic time-table, but only if your assets deviate from your goals by a pre-determined amount. Therefore, if you reach your time schedule and your assets are below the threshold, you would not rebalance. Likewise, if your assets exceed the threshold, but you haven't reached the scheduled rebalancing date, you will wait to rebalance.

For the average investor, rebalancing too frequently could result in higher tax costs (from selling assets) and added transaction fees. But many experts suggest taking a hard look at least once a year at whether your portfolio's asset mix still matches your intended goals.

How often do you rebalance your portfolio?

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Guest's picture

I try to rebalance my 401k twice a year so that it doesn't get too out of line with how I want my allocations. My Roth IRA is currently invested into a "Target Retirement" fund that auto balances for me, so that saves some time. The expense ratio is slightly higher on that though.