If you’ve ever heard the term “portfolio rebalancing”, you’ve probably wondered what it is and why—or if—it’s important. I would argue that it is important, and should be properly done.
Portfolio rebalancing is something that becomes necessary when your investment portfolio strays too far from its intended balance. For example, let’s say that you’ve taken a risk assessment and determined that 70% equities and 30% bonds is an appropriate portfolio for you. You buy the assets. Your stocks have a great run, and 6 months later they’ve gone up 20%. Unless bonds have similarly surged during those 6 months, your portfolio has likely become unbalanced. You might have 75% equities and 25% bonds at that point.
Since you already know in our example that the best allocation for you is 70/30, you need to go ahead and sell some stocks and buy some more bonds in order to bring your portfolio back into balance at 70/30. This is where the name “portfolio rebalancing” comes from.
There’s actually a science to rebalancing that the simplified example above doesn’t capture, so let me expand a bit.
The science comes in when we ask the question “how do I know when to rebalance?” That’s the million-dollar question! One major factor is determining how far an account can fall out of balance before it should be brought back in to balance. Every day your portfolio is likely to fall out of balance at least a little bit. But it would make no sense to rebalance daily for a number or reasons, from time spent to taxes to eliminating the compounding effects of momentum. In terms of the tax piece, anything that you sell at a profit in a taxable investment account will generate a tax bill at the end of the year (retirement accounts let you avoid this indignity).
It is my belief that you should consider rebalancing as your portfolio approaches a 5% loss of balance. That could be 5% of your allocation of stocks and bonds, it could be 5% of your allocation of U.S. versus International companies, or any of a number of other measures.
If are fortunate enough to be putting in new investment dollars will some regularity, you can use those new dollars to purchase investments in a way that rebalances your portfolio without having to sell anything or take a task consequence. I frequently do that for my clients. It’s a fantastic way to keep your investments aligned with your risk tolerance!
How ever you choose to keep your portfolio in balance, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past Performance does not guarantee future results. Consult your financial advisor before purchasing any security.
