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5 Factors to Consider When Rebalancing Your Portfolio

As an investor, boosting your return rates is probably your primary concern. But no matter how carefully you’ve selected the stocks and bonds in your portfolio, it’s a good idea to make some adjustments every once in a while to minimize the amount of risk you’re taking on. Before you rearrange your assets, however, there are five important factors you’ll need to consider.

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1. Your Asset Allocation

Rebalancing is the act of switching up your investments to get back to the asset allocation you’re most comfortable with. Your asset allocation is the mix of securities you have in your portfolio based on your risk tolerance. For example, if you’re very risk-averse, it’s best to have mostly bonds and cash in your portfolio.

Over time, the percentage of stocks, bonds and cash investments that you have will shift automatically as certain securities outperform others. Maybe stocks made up only 20% of your portfolio when you first started out, but because the ones you chose are doing well, they now make up 40% of your assets. When you rebalance, you’ll need to sell off some of those high-performing equities and buy other assets so that stocks only make up 20% of your portfolio again.

After rebalancing your portfolio, you might not end up with the same returns, at least in the short term. But chasing returns is not the point of rebalancing. It’s important to rebalance from time to time to avoid having too much risk. Even if all of your stocks have high return rates right now, their values could fall.

2. How Frequently You’ll Rebalance

5 Factors to Consider When Rebalancing Your Portfolio

Now that you know what rebalancing is, you’ll need to decide how frequently you’ll do it. That’ll depend on your investment goals. Never rebalancing your portfolio can put you in a risky predicament. But rebalancing too frequently or in reaction to what’s happening in the economy can be just as dangerous if it means you’re paying a lot in fees and taxes.

You can rebalance periodically, such as quarterly or every other month. Or you can rebalance a couple of times a year. Either way, it’s best to rebalance whenever your portfolio drifts too far from your asset allocation or when your plans change. For example, you may need to become more of a conservative investor because you’ve decided to retire early.

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3. Your Rebalancing Threshold

You can’t determine how frequently you’ll rebalance unless you choose a rebalancing threshold. That’s a percentage that represents how far your assets have strayed from your asset allocation.

Will you rebalance if your portfolio weights are 1% off? Or will you wait to rebalance when they’re 5% or 10% off? Those are questions you’ll have to answer based on your personal circumstances. If you need assistance, you can always contact a financial advisor.

4. The Costs of Rebalancing

5 Factors to Consider When Rebalancing Your Portfolio

Before you buy or sell a single security, you’ll need to make sure you can afford to rebalance. Can you cover the fees you might have to pay upfront for purchasing a new asset or selling off one you currently have? It’s also a good idea to look at the expense ratio of the securities you’re interested in. That tells you what percentage of your assets are going toward management fees.

Besides the financial consequences of rebalancing, you’ll need to remember that the process could be somewhat time consuming. It’ll take longer than a few minutes to finish, so you’ll need to make room in your schedule to rebalance.

5. How Rebalancing Will Affect Your Tax Bill

Along the same lines, you don’t want to forget about the tax implications of rebalancing. You won’t owe taxes for switching out securities in your 401(k) or IRA, since they’re tax-deferred. If you have taxable accounts, however, you’ll pay capital gains taxes when you sell an asset and its value has increased since you bought it.

To minimize your capital gains tax bite, you can use tax-loss harvesting. That means you’ll sell off your low-performing securities to offset your capital gains. Or you can wait a while before selling an asset. Short-term investments are taxed at a higher rate than the ones you hold onto for more than a year.

Related Article: 4 Ways to Minimize Capital Gains Taxes on Investments

The Takeaway

Rebalancing involves selling off some assets and buying others to make sure you’re hitting your target asset allocation. When it comes to investing, there’s no hard rule on how often you should readjust your portfolio. By taking the factors we’ve mentioned into account, you’ll be able to use rebalancing to your advantage and minimize your overall risk.

If this all sounds like a lot to handle on your own, consider working with a financial advisor. An advisor can manage your portfolio and rebalance as needed. SmartAsset’s financial advisor matching tool can help you find an advisor who suits your needs. First you’ll answer a series of questions about your financial situation and goals. Then the program will pair you with up to three advisors in your area based on your answers. You can then read the advisors’ profiles and interview them to 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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Amanda Dixon Amanda Dixon is a personal finance writer and editor with an expertise in taxes and banking. She studied journalism and sociology at the University of Georgia. Her work has been featured in Business Insider, AOL, Bankrate, The Huffington Post, Fox Business News, Mashable and CBS News. Born and raised in metro Atlanta, Amanda currently lives in Brooklyn.
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