Choosing the right asset allocation matters for achieving your investment goals. But it isn’t just set-it-and-forget-it. Rebalancing your portfolio from time to time is necessary to ensure that you have the right mix of investments, based on your goals and risk tolerance. The question is, when do you need to rebalance? Knowing how often to rebalance portfolio allocation is a basic – yet important – investing lesson to learn. A financial advisor can offer valuable insights as you rebalance your portfolio.
What Is Portfolio Rebalancing and Why Is It Important?
Portfolio rebalancing simply means adjusting the weightings of different assets in your portfolio. This is achieved by buying and/or selling securities to bring your asset allocation back in line with your goals.
For example, say you prefer to hold 80% of your investments in stocks and 20% in bonds. But higher-than-expected returns have pushed the stock portion of your portfolio to 90%. To get back to your ideal 80/20 mix, you’d have to sell off some of your stocks or purchase more bonds to act as a counterweight.
Portfolio rebalancing matters for maintaining the appropriate level of risk in your portfolio. Say you’re more risk-averse and prefer to hold a higher proportion of bonds. If you don’t rebalance, you could expose yourself to more risk than you’re comfortable with if the stock portion of your portfolio grows.
On the other hand, failing to rebalance could mean you’re not taking enough risk to achieve your investment goals. You could end up with too much of your money in bonds or fixed-income investments, which could limit your portfolio’s growth potential.
Rebalancing regularly can help with maintaining a diversified portfolio. It’s also an opportunity to take a closer look at what you own to decide if those investments still match up with your needs and objectives.
How Often to Rebalance Portfolio?
Deciding how often to rebalance your portfolio is entirely a personal decision. You could do it monthly, quarterly, biannually or once a year. The advantage of using a time-based approach is that it’s easier to get into a habit of rebalancing, so you don’t forget to do it. And while you’re rebalancing, you may tackle other tasks as well, such as reviewing expense ratios for the mutual funds or exchange-traded funds you hold or commissions you’re paying to your brokerage.
You can also choose to rebalance once your asset allocation reaches a specific tipping point. So again, say you’re focused on investing 80% of your portfolio in stocks and 20% in bonds. You may set a rule for yourself to rebalance any time the stock portion of your portfolio grows to 85%. This is a fairly standard rule of thumb to follow, though you may choose a different percentage instead. For example, you may decide to rebalance if your asset allocation changes by 10% or 15%.
The advantage of rebalancing this way is that it allows you to avoid having your portfolio allocation be off-kilter for extended periods of time. If you were to only rebalance once a year, for example, it’s possible that you could go most or all of the year with an asset allocation that doesn’t match up to your goals or risk tolerance.
The key with either approach is to avoid overdoing it. Say you follow a set calendar for rebalancing quarterly. Rebalancing just because it’s time to rebalance may be counterproductive if your asset allocation hasn’t shifted course in a major way. Likewise, rebalancing once your asset allocation moves beyond a set percentage range could be problematic if it means paying more fees to your brokerage.
While many brokerages have adopted $0 commission trades for U.S. stocks and ETFs, fees may still apply to trade mutual funds or bonds. So even though rebalancing could help you to keep your portfolio in line, it may mean paying higher fees.
How to Rebalance Your Portfolio
If you want to rebalance your portfolio, the first step is to take an inventory of your current holdings. Specifically, you’ll want to break down what percentage of your portfolio is dedicated to different asset classes, i.e. stocks, bonds, cash and cash equivalents, real estate, etc. You can also drill down even further by looking at your allocation to domestic versus international investments and by market sector.
So if 80% of your portfolio is made up of stocks, for example, consider:
- How much of that is U.S. stocks
- How much is international stocks
- Which stock sectors you own (i.e. healthcare, financials, utilities, etc.)
- Whether you own more large-caps, mid-caps or small-caps
- How much of your investments are in growth vs. value stocks
Digging deeper into your holdings can help you quantify which type of investments you need and want to have in your portfolio, based on your preferred investing strategy. If you set your asset allocation by age, for example, then your ideal allocation should reflect the level of risk that a person in your age range would typically be comfortable with.
Once you know what you own and what your ideal asset allocation should be, you can rebalance by buying or selling securities as needed. You may also want to consider asset location along with allocation. Asset location means where you keep your investments.
So you might have money invested in a taxable brokerage account, a 401(k) plan at work and an individual retirement account (IRA). All three have different tax profiles and all three may offer a different range of investments or charge different fees. When rebalancing, it’s important to consider the entirety of your portfolio across all investment accounts to decide where to keep which assets.
For example, your 401(k) may include target-date funds. These funds base their asset allocation on your target retirement date, then rebalance themselves automatically as you get nearer to that date. If the majority of your 401(k) is invested in a target-date fund then you may not need to do much to rebalance. But you’d still want to look at the fund’s underlying holdings and compare them to the funds you hold in your IRA or brokerage account. This way, you can avoid becoming accidentally overweighted.
Also, consider whether it makes sense to let an algorithm rebalance for you if you’re investing with a robo-advisor. Some, though not all, robo-advisory platforms include automatic rebalancing as an account feature. The pro is that you don’t have to do any heavy lifting to rebalance. The con, of course, is that rebalancing decisions are guided by an algorithm rather than a human perspective. So that’s one reason you may still want to talk to a financial advisor about the right way to rebalance.
The Bottom Line
There’s no single answer for how often to rebalance a portfolio. At a minimum, it can be helpful to review your portfolio and rebalance as needed at least once a year. The important thing when deciding how often to rebalance is to choose a frequency that fits your overall investing style.
Tips for Investing
- If you’re considering a robo-advisor for automatic rebalancing, remember to weigh the costs as well as the other features that may be included. Robo-advisors typically charge an annual management fee which may or may not be tiered based on your account balance. So you might pay a management fee of 0.25% or 0.30%, which is lower than the 1% typically charged by human advisors. But think about what you’re getting in return, aside from automatic rebalancing. Is tax-loss harvesting included? Do you have the opportunity to speak to a human advisor if needed? Asking those kinds of questions can help you decide if a robo-advisor is right for you.
- Consider talking to a financial advisor about the ins and outs of portfolio rebalancing and why it’s important. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in 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.com/fotofrog, ©iStock.com/Dishant_S, ©iStock.com/BernardaSv