Rebalancing Your Investment Portfolio to Stay on Track
February 15, 2019 - Two columns ago, I embarked on a series of rational investment strategies for volatile markets. So far, I’ve talked about disciplined and sensible investing. Today, let’s talk about keeping your investments on track over time. Fortunately, there’s a disciplined process for doing just that. It’s called rebalancing.
Imagine it’s your first day as an investor. As you create your new portfolio, I hope you do so according to a personalized plan that prescribes how much weight you want to give to each asset class: X% to stocks, Y% to bonds, etc. This is called asset allocation.
Then time passes. Markets shift around. Some investments outperform others, which increases their allocation percentage. Others underperform and their allocation decreases. The secret is, while certain asset classes are expected to outperform others over the long haul, all of them take turns along the way at being best, worst and so-so for a while. And counterintuitively, today’s likely overpriced winner is most likely to be tomorrow’s dud – and vice versa.
Rebalancing your portfolio investments back to their target allocation requires you to sell the expensive outperformers and buy the cheap underperformers. In this objective process you sell high and buy low.
Rebalancing helps you keep your portfolio on track toward your goals. Better yet, the trades are not a matter of random guesswork or emotional reactions. They’re done according to plan.
I will add one caveat: Trading incurs fees and potential taxes, so you don’t want to rebalance until you need to. I suggest rebalancing strategically instead of on a set periodic schedule. To rebalance strategically, only do so when your asset mix moves beyond predetermined bands. For example, if an asset is supposed to make up 10% of your portfolio, don’t rebalance it unless it’s moved above 12% or below 8%.
Ideally, it’s also a good idea to be mindful of how to rebalance across your various account types – such as regular/taxable, IRA, Roth, 401(k), etc. – to minimize those taxes and trading costs. But know that this can get tricky; it’s one area where you may need professional assistance.
Written by John A. Frisch, CPA/PFS, CFP®, AIF®, PPC®