How to Rebalance Your Portfolio to Stay on Track

Investing can be rewarding, but the journey to success is not without its twists and turns. Maintaining a well-balanced portfolio is one of the most crucial aspects of managing your investments. Over time, as different assets perform differently, your portfolio can drift away from your original investment strategy. This is where rebalancing comes into play.

Today, we will explore the importance of portfolio rebalancing and how it can help you stay on track toward your financial goals.

The Essence of Portfolio Rebalancing

Portfolio rebalancing is realigning your investments to maintain your desired asset allocation. When setting up your investment portfolio, you allocate a certain percentage of your funds to different asset classes, such as stocks, bonds, real estate, and cash.

This allocation is based on your financial goals, risk tolerance, and investment horizon. However, as time goes by, the values of these assets can fluctuate, causing your portfolio to deviate from your original allocation.

Karolina Grabowska/ Pexels | Rebalancing requires selling securities and paying taxes

For example, let’s say you initially allocated two-thirds of your portfolio to stocks and the remaining to bonds. If stocks perform well and increase in value, they might make up 70% of your portfolio, while bonds have dwindled to 30%. This shift can expose you to more risk than initially intended, potentially jeopardizing your financial goals.

Why Rebalancing Matters

Risk Management

Rebalancing helps you manage risk effectively. By bringing your portfolio back in line with your original allocation, you can control the level of risk you’re exposed to. This means you won’t be overexposed to one asset class that might suffer a downturn.

Maintain Your Investment Strategy

Rebalancing is a strategy that helps your financial moves align with your long-term goals. If your strategy is to have a balanced portfolio, rebalancing is crucial to preserving that balance.

Lock in Gains

Rebalancing allows you to sell assets that have performed well and reallocate the profits to underperforming assets. This “sell high, buy low” approach helps you lock in gains and potentially benefit from the future growth of undervalued assets.

Leeloo Thefirst/ Pexels | Time is an investor’s ally

Discipline

Regularly rebalancing your portfolio instills discipline in your investment approach. It prevents you from making impulsive decisions based on market fluctuations and emotions.

When to Rebalance

The timing of portfolio rebalancing can vary depending on your investment strategy and personal preferences. Here are a few common approaches:

Calendar-Based

Some investors rebalance their portfolios at specific intervals, such as annually or semi-annually. This method provides a systematic approach but may not always meet market conditions.

Percentage Deviation

Others prefer to rebalance when their asset allocation deviates from their target by a certain percentage. For example, if your target allocation for stocks is 60%, you might rebalance when stocks make up 65% or 70% of your portfolio.

Threshold-Based

A more conservative approach is rebalancing when the deviation exceeds a predetermined threshold. For instance, you may rebalance only if an asset class deviates by 5% or more from its target allocation.

Tima Miroshnichenko/ Pexels | In investing, what is comfortable is rarely profitable

Opportunistic

Investors often tweak their portfolios when they sense the moment is ripe for change in the market. It’s like a finely tuned dance—knowing when to sway and shift to the rhythm of the market’s beat.

The trick? It’s finding your groove, syncing your approach with your goals, how much risk you’re comfortable with, and how hands-on you want to be in steering your investments. It’s like crafting your own melody that resonates with your financial tune.

How to Rebalance Your Portfolio

Rebalancing your portfolio involves several steps:

1. Review Your Portfolio: Start by assessing your current asset allocation. Identify how much of your portfolio is allocated to each asset class and compare it to your target allocation.
2. Determine Which Assets to Rebalance: Identify the assets that have deviated significantly from their target allocation. These are the ones you’ll need to adjust.
3. Sell and Buy: Sell a portion of the overperforming assets and use the proceeds to buy the underperforming assets. This action brings your portfolio back in line with your target allocation.
4. Tax Considerations: Be mindful of the tax implications when rebalancing. In taxable accounts, selling assets can trigger capital gains taxes. Consider tax-efficient strategies to minimize the impact.
5. Costs: Keep transaction costs in mind when rebalancing. Frequent trading can erode your returns through fees and commissions. Look for cost-effective ways to make the necessary adjustments.