When you strive to live a healthy (and happy) lifestyle, it’s all about finding balance. For some that might mean following a pizza dinner with a salad the next night, and for others balance might look like taking a morning walk three times a week and sleeping in the other days.
Whatever balance looks like in your world, the goal is to find a blend between behaviors that may carry more risk, but offer a higher reward, and those that are less risky in the long run. You may think about balance within your investment portfolio the same way.
But just like taking a vacation could throw off your diet or a long weekend can wreak havoc on your sleep schedule, sometimes, the balance between the assets in your portfolio may get thrown a little out of whack due to market changes. When that happens, it may be time to rebalance your portfolio to better align with your investment goals and risk tolerance. So, read on to dig into the practice of rebalancing.
What is portfolio rebalancing?
Rebalancing means realigning the weight of the different assets in your portfolio to maintain your desired asset allocation based on your risk appetite. The process involves periodically reviewing your investments to maintain balance between securities that tend to carry more risk (like ETFs or stocks) and more conservative investments (like municipal or treasury bonds).
Let’s take a look at a simple example: Say you prefer to keep a moderate portfolio and aim for a balance of 50% stocks and 50% bonds. You have $10,000 to invest and split it evenly between the two asset classes. In five years, your stocks have doubled in value and are now worth $10,000, but your bonds only grew 20% and are worth $6,000.
Now your portfolio is worth $16,000, and while all your investments have grown, your stocks grew at a higher rate than your bonds. Those securities now make up almost 63% of your total investments — meaning you no longer have a 50-50 stock-to-bond asset allocation. Because stocks, the higher-risk asset, now make up a heavier portion of your investments, your portfolio is more reliant on their success.
To return to your original asset allocation, you can choose to reallocate portion of your investments in the high-performing stocks in your portfolio to purchase more bonds.
Keep in mind: Gains are never guaranteed in the stock market, and you may have to rebalance after sustaining losses. If low-value stocks cause your asset allocation to skew more heavily toward bonds or other securities, you may want to rebalance to return to the balance that you desire.
When should you rebalance?
There’s no required time schedule for rebalancing your portfolio, but it’s typically recommended to check in on your asset allocation at regular intervals — whether it’s monthly, quarterly, or annually. That way, you don’t have to monitor all of the small up and down movements your investments will make, but you’ll still stay on top of the bigger-picture changes happening in your portfolio.
This will also give you a chance to review gains or losses on your investments and decide whether to redirect your investments elsewhere.
Another method for determining when to rebalance is only doing so when your asset allocation has changed significantly. For example, if your desired balance is 60% stocks and 40% bonds, you might rebalance any time the weight of stocks shifts more than 10% in either direction.
You’ll just want to make sure you keep an eye on your portfolio and don’t react too quickly to short-term volatility.
What else should you consider when rebalancing?
When you rebalance your portfolio, the goal is to align your portfolio with your desired asset allocation. And as you invest over time, it’s likely that your desired asset allocation will change. As your goals shift, your time horizon can change, and your risk tolerance may fluctuate. Those changes can impact the assets in which you invest.
For example, the way you invest in your future when you’re starting a career will likely be different than when you’re close to retirement. You are likely to have a higher risk tolerance in your 30s than in your 60s , which may translate to a heavier allocation of stocks than bonds at earlier stages of life. As these changes develop, you’ll want to reassess your portfolio and decide whether to rebalance your portfolio to reflect your risk tolerance.
On the other hand, you may find yourself able to take on a more aggressive asset allocation. Say your goal is to buy your first home in two years, so you invest to help build wealth for your down payment. Then your plans change, and you decide to hold off purchasing a home for an additional five years. In this scenario, since you now have a longer time horizon, you might then choose to take a slightly more aggressive asset allocation depending on your financial situation and risk tolerance.
Your overall risk tolerance will likely change with age and time, but can also fluctuate based on your income level, your specific investment goals, and other lifestyle changes. It’s likely that you’ll want to rebalance if you get married and combine finances with your partner, if you lose or change jobs, or if you have children.
Your personal financial situation changes throughout life, and your current state often impacts how much risk you can handle in the market.
As you do your best to live a healthy existence, you need to periodically factor in changes to your life and routine. And when that happens, you have to take the time to reset — just like you should with your investments. Rebalancing is all about coordinating your appetite for risk with how much you’re exposed to it and keeping your portfolio current with your investment goals, even when the market changes. By taking a systematic approach and revisiting your asset allocation at planned intervals, you can take some of the emotion out of investing and ensure a balance of securities that makes sense for you.
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