If you’ve strayed away from your original asset allocation, rebalancing can help you get back on track. And if you want to lower your investment risk, rebalancing can protect your portfolio from market volatility. Before you make adjustments, however, it’s best to avoid doing anything that could jeopardize your investment strategy. Here are four rebalancing mistakes you can’t afford to make.
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1. Only Focusing on the Losers
When you’re rebalancing, it’s okay to replace investments that are causing you to lose money. But it’s important to take a look at the ones that are performing well, too. If you don’t, you could be exposing yourself to too much risk.
If you want to shuffle things around in your portfolio, it’s a good idea to take a step back and look at the big picture. If your stock holdings have made major gains while your bonds are lagging far behind, for example, you might need to find a way to even that out without throwing your asset allocation out of whack.
2. Making Sweeping Changes When You’re Inexperienced
Rebalancing can be an overwhelming task for less experienced investors. If you don’t know what you’re doing, you might be tempted to give up or even worse, make a move without thinking it through.
If you’re trying to rebalance and you don’t know where to begin, you can start by making small changes. For instance, if you’ve noticed that a large percentage of your assets are tied up in cash, you can redirect some of those funds into investments that offer better returns.
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3. Ignoring the Tax Bite
As you rebalance, you’ll need to pay attention to how it might affect your tax bill. Selling profitable investments can trigger the capital gains tax. But luckily, you can minimize your tax bite by selling off assets that have experienced a loss and replacing them with others.
If you decide to use this strategy (known as tax loss harvesting), it’s important to tread carefully. If you replace a stock 30 days before or after selling one that’s almost identical to it, you’ll break the IRS’s wash-sale rule. If that happens, you won’t be able to use the loss to offset any of your gains until you sell off the similar shares later on.
4. Not Looking at Your Mutual Funds’ Underlying Investments
Mutual funds allow investors to diversify their portfolios without choosing individual stocks. But some mutual funds include the same underlying investments. For instance, if you’re investing in a couple of mutual funds that track the same market index, there’s a good chance that there will be some overlap between the two.
Rebalancing could be a waste of time if you don’t pay attention to the underlying holdings in your mutual funds. Even if you think you’re switching things up, you could simply be buying the same investments. That won’t help you if you’re trying to create a balanced portfolio.
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Rebalancing isn’t rocket science. But you’ll need to be strategic in order to take advantage of the benefits it offers. Avoiding any of these mistakes is a good idea if you want to minimize your risk and maximize your investment returns. And don’t hesitate to turn to a financial advisor if you need some guidance. A financial advisor can take the tasks of monitoring and rebalancing your portfolio off your hands.
A matching tool like SmartAsset’s can help you find a financial advisor to work with to meet your needs. First you’ll answer a series of questions about your financial situation and goals. Then the program will narrow down your options to up to three suitable advisors in your area. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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