Rebalancing a portfolio involves adjusting the asset mix to maintain a desired allocation, which can help align investments with specific financial goals. The benefits of rebalancing a portfolio include helping to manage risk, as assets that have grown significantly may alter the intended balance of risk and reward. By periodically realigning the portfolio, investors may also be able to take advantage of market opportunities by selling high-performing assets and reinvesting in undervalued ones. This process can contribute to a more consistent investment strategy over time, potentially enhancing the overall risk-adjusted return.
A financial advisor can help you rebalance your portfolio to fit your personal risk tolerance and guide you toward a desired asset allocation.
What Is Portfolio Rebalancing?
Portfolio rebalancing is the process of adjusting the allocation of assets within an investment portfolio to match your target asset mix.
Investors typically establish a target allocation based on factors like their risk tolerance, investment goals and time horizon. For example, a common asset allocation might be 60% stocks and 40% bonds. Over time, as asset values fluctuate, the allocation can drift away from this target. Stocks might increase in value, pushing the portfolio to 70% stocks and 30% bonds, thus increasing its risk profile.
To rebalance, the investor would sell a portion of the stocks and purchase more bonds to bring the portfolio back to its original 60/40 split. This process helps ensure that the portfolio remains aligned with the investor’s goals and risk tolerance while avoiding unwanted exposure to market volatility. This not only helps manage risk but can also enhance long-term performance by consistently realigning assets to meet the investor’s target allocation.
Rebalancing can be done at regular intervals, such as quarterly or annually, or when the portfolio drifts beyond a specific threshold.
Benefits of Portfolio Rebalancing
Regularly rebalancing your portfolio offers several advantages that can improve your overall investment experience. These are some of the benefits of rebalancing portfolio investments:
1. Risk Management
Regularly rebalancing your investment portfolio can help manage risk effectively. As different asset classes, such as equities, bonds and cash, perform differently over time, a portfolio that initially had a balanced risk level can shift to be riskier or more conservative than intended.
Rebalancing helps restore the original asset allocation, which keeps the portfolio’s risk profile in line with an investor’s preferences. By trimming back investments that have grown disproportionately, rebalancing reduces the chance of an overexposure to high-risk assets, providing a more consistent approach to managing market uncertainties.
2. Disciplined Investment Approach
Portfolio rebalancing also supports a disciplined investment approach. Emotional decisions during periods of market volatility can undermine long-term financial goals. Rebalancing involves systematically adjusting allocations based on a predetermined strategy, rather than reacting impulsively to market swings.
This practice encourages the habit of selling high-performing assets and buying those that are underperforming, effectively buying low and selling high. The discipline enforced by rebalancing can prevent an investor from chasing short-term gains or panic-selling during downturns, fostering a steady path toward financial objectives.
3. Enhanced Long-Term Performance
Another benefit of portfolio rebalancing is the potential to enhance long-term performance. By periodically reviewing and adjusting asset allocations, investors can ensure that their portfolios are optimized for growth.
Although frequent rebalancing doesn’t guarantee higher returns, it can improve the overall risk-adjusted return by consistently managing risk and seizing opportunities presented by undervalued assets. This approach often helps smooth out the highs and lows of portfolio returns over the long run, contributing to a more stable and potentially profitable outcome.
4. Alignment with Financial Goals
Financial goals can change over time, whether it’s saving for retirement, funding a child’s education, or other long-term aspirations. Rebalancing helps keep a portfolio aligned with these evolving objectives.
For instance, as investors approach retirement, they may want to reduce exposure to risky assets and focus more on stable income-generating investments. Regular rebalancing allows for such adjustments, ensuring that the asset allocation reflects not only market conditions but also the investor’s changing time horizon and financial needs. Maintaining alignment with personal financial goals helps provide a smoother progression toward achieving them.
5. Better Adaptation to Market Changes
Market conditions are constantly evolving, and rebalancing helps investors adapt to these changes more effectively. As asset classes move differently in response to interest rates, economic growth or global events, rebalancing takes advantage of shifts in valuations. When certain investments underperform while others outperform, rebalancing involves strategically reallocating funds to better-positioned assets, potentially capturing value in down markets.
This proactive adaptation ensures that investors aren’t overly reliant on the performance of a single asset class and can adjust to prevailing market dynamics, resulting in a balanced and diversified investment strategy capable of weathering a range of market environments.
Bottom Line
Regularly rebalancing your portfolio is a proactive way to maintain your desired asset allocation, manage risk and stay aligned with your financial goals. Although it does not eliminate risk or guarantee profits, rebalancing offers a structured approach to keep your portfolio resilient over time. The benefits of rebalancing include better risk management, improved long-term performance and a disciplined investing strategy. By making rebalancing a regular part of your investment routine, you can create a portfolio that adapts to market changes and supports your financial journey.
Frequently Asked Questions
Does Rebalancing Have Costs?
Yes, rebalancing can involve costs. These can include transaction fees for buying and selling securities, as well as potential opportunity costs. For instance, by selling high-performing securities to restore your target allocation, you might miss out on further gains if those assets continue to rise. However, by including rebalancing as part of your investment plan, you can anticipate these costs and weigh them against the benefits of maintaining your desired asset allocation.
How Often Should I Rebalance?
The frequency of rebalancing depends on your individual investment goals, risk tolerance and financial needs. Long-term investors who prefer a buy-and-hold approach may choose to review and rebalance their portfolio annually, often with the guidance of a financial advisor. On the other hand, investors with shorter-term goals might consider rebalancing more frequently, such as quarterly, to ensure they remain aligned with their objectives.
Investment Management Tips
- Tax efficiency is an often overlooked element of portfolio management. Strategies like holding investments in tax-advantaged accounts, using tax-loss harvesting to offset gains, and being mindful of the tax implications of frequent trading can help preserve more of your returns. For instance, placing dividend-paying securities in a tax-advantaged account (like an IRA) can reduce tax drag, while holding growth stocks in taxable accounts may be beneficial since taxes are only incurred upon sale.
- While some people prefer the DIY option to investing, you may benefit from working with an investment professional. A financial advisor can select investments based on your goals and risk tolerance, and then manage your portfolio for you. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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