Rebalancing Explained: What Is It and How Can It Help You?


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When you invest your money you are looking to get the maximum reward with the minimum amount of risk.

In this article we will talk about what type of strategy and actions that will provide this outcome for you.

What is Asset Allocation?

Asset Allocation is an investment strategy that attempts to balance the reward and risk of investing by allocating assets according to an investor’s goals, risk tolerance and the length of time an investor wants to hold a security or portfolio (investment horizon).

When we refer to assets there are three main classes

  • Equities
  • Fixed-income,
  • Cash and equivalents

Each of these classes differ with their levels of risk and return and will behave differently over time.

Asset Allocation and Risk

Asset allocation is all about risk.

When you build an investment portfolio it is wise to allocate money to a variety of asset classes in order to balance out the portfolio’s potential for growth while mitigating some of the downside risk

One way that you can mitigate risk is to include some asset classes that in relation to the portfolio as a whole have a low level of correlation to each other.

What is Rebalancing?

Rebalancing is closely related to asset allocation.

Rebalancing periodically realigns the weight of assets in a portfolio. This realignment involved buying or selling assets to bring the investor back in line with the original asset allocation goal.

As an example let’s say you have a portfolio that is 50% stocks and 50% bonds. Let’s also say I had a good run with my stocks and the weighting of the stocks in the portfolio has now become 75%.

So in order to re-balance our portfolio to the 50/50 allocation you would sell some stocks and buy bonds.

Rebalancing Provides Discipline

Rebalancing helps curb an investor’s instinct to “let things ride” when they are doing well and to sell everything off when they are not. I call this emotional investing and it always turns out bad. For myself I find it enjoyable when the market is doing poorly because if I stick to my plan I am buying at a discount. In addition, market corrections happen on average once a year and average about 2 and a half months worth of trading days, so riding it out really isn’t that bad.

Rebalancing imposes a sane discipline by selling off some of the winners to put the money back into asset classes that in the near term are underperforming or simply not performing as well as other classes.

Intervals for Rebalancing Assets

Many advisors advise rebalancing your portfolio at least annually.

You shouldn’t rebalance more than semiannually. Some 401(k) plans offer auto-rebalancing and you should definitely make sure that the auto-rebalance feature doesn’t happen more than this,

Rebalancing too frequently can have consequences.

First there are costs associated with rebalancing – such as transaction costs for things like stocks or mutual funds. You might also have capital gains costs as well.

Rebalancing Tips

Use New Money

New money from something like an annual work bonus can be a good portfolio balancing tool.

Invest money like this in areas of your portfolio that need extra dollars to rebalance.

With taxable accounts this removes the worry about the impact of taxable gains that occur from rebalancing,

Review Your Complete Portfolio

It is advisable to look at the entirety of your portfolio. Include tax-deferred accounts like a 401(k) and investments that are contained in taxable accounts.

You may consider income from pensions, annuities and Social Security – especially if income from these represent a significant portion of your income in retirement.

Consider Where to Buy and Sell

You should not only look at your complete portfolio when rebalancing but also consider where you want to buy and sell assets in order to rebalance.

An example of this might be selling off some appreciated equity and having a relatively high taxable income for the year. In such a case you might consider rebalancing in an IRA or in your 401(k).

Avoiding taxable transactions by rebalancing might be a smart move.

Assess and Rebalancing

Remember to review your entire portfolio, your risk tolerance and long term investment goals.

This will help you establish a strategy of asset allocation and rebalancing that will provide you the most return while minimizing your risk.

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