When it comes to creating and maintaining a portfolio to build wealth, diversification in a wide range of assets is key. But once an investor has put together their portfolio, they’ll be faced with the question of how often to rebalance that portfolio to maintain an ideal mix of stocks, bonds, and other assets.
Generally, investors can rebalance their portfolios as often or as little as they want. It all depends on individual circumstances and goals. Here’s what to know to execute this investment strategy.
What Is Portfolio Rebalancing?
Portfolio rebalancing is a way to adjust the asset mix of investments. It means realigning the assets of a portfolio’s holdings to match an investor’s desired asset allocation.
The desired allocation of investments in an investor’s portfolio — a combination of assets like stocks, bonds, mutual funds, commodities, and real estate — should be made with individual risk tolerance and financial goals in mind.
For example, an investor with a conservative risk tolerance might build a portfolio more heavily weighted towards less volatile assets, like bonds. The conservative investor may have a portfolio with 60% bonds and 40% stocks. In contrast, a younger investor may be more comfortable with riskier assets and build a portfolio with more stocks. The younger investor’s portfolio may have an asset allocation of 70% stocks and 30% bonds.
Over time, however, the different asset classes will likely have varying returns. So the amount of each asset changes — one stock or fund might have such high returns it eventually grows to be a more significant portion of the portfolio than an investor wants.
For example, if the younger investor aims to have 70% stocks and stock prices go up drastically during a year, the portfolio may consist of 80% stocks. That’s when it could be time for the investor to rebalance to maintain the target allocation of stocks.
Why You Should Rebalance Your Portfolio
Investors should rebalance their portfolios because it’s the only way to maintain their target asset allocation. This can help investors stay on track to reach long-term financial goals.
The target asset allocation is a plan outlining the percentage of each asset class an investor wants to hold in their portfolio. A target asset allocation is based on investor goals and risk tolerance.
It might be tempting to think that if a specific asset has outperformed, one should keep a higher portion of their portfolio in that asset and not rebalance. But if an investor doesn’t rebalance, the portfolio may eventually drift away from the target asset allocation. This can be a problem because it can change the amount of risk in a portfolio.
How Often Do You Need to Rebalance Your Portfolio?
Investors can rebalance their portfolios whenever they want, depending on personal preferences.
Some investors rebalance their portfolios at set time points, whether monthly, quarterly, or annually. For many people, it makes sense to use these time markers to examine the asset allocation of their portfolios and decide if their investments need adjusting. This time-based approach makes it easier to get in the habit of rebalancing.
The downside of rebalancing at set calendar points is that investors may risk rebalancing needlessly. For example, if an investor’s portfolio drifted just 1% from stocks to bonds at the end of the quarter doesn’t mean they should rebalance. Rebalancing a portfolio with little asset drift might lead to unnecessary transaction costs and other investment fees.
In contrast, other investors rebalance at set allocation points — when the weights of assets in a portfolio change a certain amount. An investor may rebalance a portfolio when the target asset allocation drifts a certain percentage, like 5% or 10%.
Determining how often an investor should rebalance their portfolio also depends on how active they want to be in their investment management and what stage of life they’re in — maybe those closer to retirement will want to rebalance more frequently as a risk-avoidance strategy.
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How to Rebalance Your Portfolio
An investor can rebalance a portfolio themselves by selling some assets that are above the target asset allocation and using the proceeds to buy up securities that are below the target allocation. Most online brokerages allow investors to buy and sell securities for minimal fees.
Investors who plan to rebalance their portfolios should keep track of quarterly and monthly statements from their brokerage and retirement accounts. These statements will give an investor a sense of the value of a portfolio and the overall asset allocation. Once the investor has a handle on rebalancing to reach a target allocation, they’ll need to buy and sell shares or securities to maintain their ideal asset allocation.
However, there can be a fine line between prudent rebalancing and harmful overtrading. While many people like to be involved and actively manage their portfolios, the downside is that active trading can lead to trading at the wrong time. Furthermore, buying and selling shares often incurs fees, which eats into the gains or any strategy an investor is trying to execute by rebalancing.
Different Types of Portfolio Rebalancing
There are several ways to rebalance investments for different goals and life stages. Three major strategies include rebalancing to ensure investments are still diversified, using so-called “smart beta” strategies, and rebalancing retirement accounts.
Rebalancing for Diversification
The most basic form of rebalancing is maintaining a diversified portfolio. Over time, a portfolio can become less diverse, as different assets have different rates of return and make up a more significant percentage of the invested money. This is where rebalancing comes in.
For example, assume an investor has a $100,000 portfolio of $60,000 in stocks and $40,000 in bonds. After one year, the value of the stock holdings increased by 30%, while the bonds grew by 5%. This portfolio now has a value of $120,000: $78,000 worth of stocks — 65% of the portfolio — and $42,000 worth of bonds — 35% of the portfolio. In this case, the investor would sell enough stocks to get back down to 60% of the portfolio, or $72,000, and buy bonds to get the allocation up to 40%, or $48,000.
An investor would likely have more detailed and sophisticated allocation goals in the real world, but this example illustrates how some simple arithmetic can guide rebalancing.
Smart Beta Rebalancing
Another approach to asset allocation is known as smart beta, a strategy that combines passive index investing with more discretionary active investing strategies. Smart beta rebalancing is typically done by portfolio managers of mutual funds and exchange-traded funds (ETFs).
With passive index investing, an investor buys a fund consisting of stocks that track the performance of a benchmark index, like the whole S&P 500. The stocks in these index funds are weighted based on their market capitalization. The managers of the index funds handle the rebalancing of holdings when market caps shift.
Smart beta is rules-based, like index investing. But instead of tracking a benchmark index weighted towards market cap, funds with smart beta strategies hold securities in areas of the market where managers think there are inefficiencies. Additionally, smart beta funds consider volatility, quality, liquidity, size, value, and momentum when weighting and rebalancing holdings. In this way, smart beta adds an element of active investing to passive investing. And as with index investing, investors can employ a smart beta strategy by buying smart beta mutual funds or ETFs, though they come with higher fees.
Rebalancing Retirement Accounts
In many cases, retirement savings are in investment accounts. Investors need to be aware of the allocation and balances of their retirement accounts, whether they’re 401(k)s, IRAs, or a combination thereof.
The principles at play are similar to any portfolio rebalancing, but investors need to consider changing risk tolerance as they get closer to retirement. Generally, investors will adopt a more conservative target asset allocation as they near retirement. Target date funds typically work by automatically rebalancing over time from stocks to bonds as investors get closer to retirement.
For investors to stay on top of this themselves, they’ll need to know how they want their investments allocated each year as they get closer to retirement and then use quarterly or annual rebalancing to buy and sell securities to hit those allocation targets.
Rebalancing an investment portfolio can help investors stay on track to meet their long-term goals. By ensuring that there is a steady mix of assets in their portfolio, they can stay on top of their investments to work with their risk tolerance and financial needs.
There are ways investors can rebalance their portfolios on their own and use different strategies. But for investors who don’t want the task of rebalancing their portfolio, there are other options. For example, the SoFi Invest® online brokerage offers automated investing. With SoFi robo investing, we’ll rebalance your investments, which means adjusting your stock and bond funds on a quarterly basis, so your money is always invested how you want it to be.
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