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What to Know About Automatic Rebalancing

SmartAsset: What to Know About Automatic Rebalancing

A diversified portfolio enables investors to minimize risk while participating in multiple investment sectors. Over time, the performance of these different sectors causes your portfolio to be out of balance. Rebalancing brings your investment assets back to your intended allocation and can be done manually or automatically. Here’s what you need to know about automatic rebalancing and how it works.

A financial advisor can help you create a financial plan for your investment needs and goals.

What Is Automatic Rebalancing and Why Is It Important?

Rebalancing is the act of buying and selling investments to return your portfolio to its intended portfolio mix. Investors choose a portfolio mix based on their appetite for risk and timeframe for reaching their goals. As investments fluctuate in value, they can deviate from the original asset allocation and become overly concentrated in one or more investments.

While many people assume that a portfolio needs rebalancing because some investments go down in value, that isn’t always the case. In an up-market, it is possible that some investments grow faster than others, causing an out-of-balance portfolio.

Automatic rebalancing is when a financial advisor, investment company or app rebalances your portfolio without your involvement. Most investment companies offer automatic rebalancing as a complimentary feature so investors don’t have to remember to do it themselves.

Example of Rebalancing

The table below shows a portfolio that has grown 10%. It shows the original mix, the amounts after the 10% gain, the amount that each asset class was changed and the amounts after rebalancing. As you can see, some investments grew and others lost, while the cash position remained the same.

Rebalancing a Portfolio That Has Gained 10%

Asset ClassOriginal amountAfter 10% GainAdjustmentsRebalanced Portfolio
Large Cap Stocks$200,000 at 40%$275,000 at 50%– $55,000$220,000 at 40%
Small Cap Stocks$100,000 at 20%$137,500 at 25%– $27,500$110,000 at 20%
International Stocks$100,000 at 20%$55,000 at 10%+ $55,000$110,000 at 20%
Bonds$75,000 at 15%$57,500 at 10%+ $25,000$82,500 at 15%
Cash$25,000 at 5%$27,500 at 5%+ $0$27,500 at 5%
TOTAL$500,000 at 100%$550,000 at 10%+ $0$550,000 at 100%

How Often Should You Rebalance Your Portfolio?

There are two primary strategies when it comes to rebalancing your portfolio. The first is based on time and the other focuses on the mix of assets. Neither is particularly right or wrong. Investors should choose one and stick with it.

Periodic rebalancing. Some financial advisors recommend rebalancing once or twice a year on a set schedule. Simply pick a date and rebalance your investments on this date every year. You can choose a common date like Jan. 1 or something more personal like a birthday or anniversary.

Percentage-based rebalancing. Others recommend rebalancing whenever your portfolio mix exceeds a certain risk tolerance. Depending on how the market performs, you may rebalance multiple times a year or none at all.

For example, if any single investment is more than 20% outside of its portfolio mix, you would rebalance your portfolio. Let’s say that an investment is 30% of your portfolio, if it falls below 24% or rises above 36% that would trigger a rebalance. This same calculation applies to all other investments in your portfolio.

Is Automatic Rebalancing a Good Thing?

SmartAsset: What to Know About Automatic Rebalancing

When rebalancing your portfolio, it can be done manually or automatically. Many investors choose to enable automatic rebalancing so that it is one less task for them to remember. Below are many of the factors to consider when setting up the automatic rebalancing of your portfolio.

Reduces risk. Automatic rebalancing reduces risk in your portfolio. The typical investor is focused on family, work and other daily responsibilities rather than tracking their portfolio on a regular basis. Because their minds are elsewhere, it is possible to miss rebalancing triggers which can add unnecessary risk to their portfolios.

Removes emotions. When investments are increasing in value, it can be emotionally challenging to sell them and buy something that isn’t performing as well. This is especially true when an investment has special meaning to an investor. Setting up automatic rebalancing removes the emotions that could prevent an investor from actively buying or selling their investments.

Hands-off approach. Automatic rebalancing removes the investor’s involvement in this mundane, but important, task. It allows them to focus on their daily responsibilities without having to track their portfolio performance for outliers or remember to rebalance on certain days.

Trading costs. While rebalancing is an important task to minimize risk, some investors may face trading costs when buying and selling investments. Working with your financial advisor, you may be able to establish workarounds to reduce or eliminate trading costs that cut overall performance.

Tax implications. Buying or selling investments may lead to tax implications for your portfolio. While there are no taxes due when trading within a retirement account, buying and selling within your brokerage account could trigger a tax bill. Before making any trades or establishing an automatic rebalancing protocol within your taxable brokerage account, talk with your financial advisor about how this may affect your taxes.

Bottom Line

SmartAsset: What to Know About Automatic Rebalancing

Rebalancing your portfolio is an important step towards reaching your financial goals. It reduces risk and ensures that your portfolio mix isn’t out of balance. While some investors choose to rebalance manually, most choose automatic rebalancing for its simplicity and time-savings. Others choose this approach because it ensures the task won’t be overlooked because of a memory lapse. Contact your financial advisor to discuss whether automatic rebalancing is right for your portfolio.

Tips for Maintaining a Diversified Portfolio

  • When choosing your investments, it is important to select a well-rounded asset allocation to minimize risk. Having a piece of a variety of market sectors, you benefit when those investments go up in value. Our asset allocation calculator helps you choose a portfolio that’s right for you when you answer a few easy questions.
  • Financial advisors use their expertise and knowledge to help investors choose an ideal portfolio mix. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock/utah778, ©iStock/utah778, ©iStock/AndreyPopov

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