Know how self-help gurus are always talking about “finding the balance” in your personal life? That same idea can apply to your money, too. Here’s what rebalancing your portfolio means––and why it matters.
Before diving into portfolio rebalancing, you need to know a few key terms about investing itself:
Putting those two concepts together can help you come up with the right mix of investments. But picking the right mix is only part of investing. The market is always changing, and when the market shifts, your portfolio shifts. Rebalancing is what you do to maintain your investment mix.
Suppose you’ve decided that the best portfolio for you is made up of 60% stocks, 35% bonds, and 5% cash.
You open a portfolio and invest your money… and then go on living your life, eating tacos, forgetting the account even exists. As the years pass, the value of your stocks gradually increases. In 10 years, your asset allocation is way off target––and you’re exposed to way more risk than you’d initially intended.
You might be saying, “Wait, what’s the problem here? My stocks grew a ton––shouldn’t I be celebrating?” And, yes, while it’s wonderful your investments gained in value, don’t forget that stocks can drop just as quickly as they rise.
So, though it’s tempting to let it ride, keeping 80% of your money in stocks means the overall value of your portfolio could plummet overnight. (In which case, you can say goodbye to Mai Tais on the beach in retirement.)
At a minimum, check your portfolio once a year. If each asset is within five percentage points of its intended allocation, you can let it lie. But if it’s more out of whack, then it’s time to rebalance, by either:
In other words, if your stocks did great and your bonds didn’t, you could sell off some of the stocks and use that money to buy bonds. Or you could keep the stocks, and use extra cash to buy more bonds.
Although rebalancing your portfolio won’t necessarily make you money, it does have several benefits (as well as a few downsides).
|Keeps your portfolio in line with your risk tolerance||Takes time and work|
|Keeps emotions out of your investment decisions||Can increase the trading fees you pay|
|Can help you buy low and sell high––the Holy Grail of investing|
If all that sounds like a lot of work––which TBH, it kind of is––then you have a few options:
If you ignore your investments for too long, you may find that your actual investment mix has drifted far from your intended asset allocation. Rebalancing is when you buy or sell investments to bring your asset allocation back in line with your targets. Though not every expert thinks it’s essential, rebalancing helps you avoid taking on too much risk or trading on emotions––which are always good things.
Rebalancing your portfolio is a way to manage your investment risk. When stocks and bonds shift in value, it can throw off your asset allocation and expose you to more risk than you should be taking on. You can rebalance by examining your portfolio each year and buying or selling investments until you’re back at your targeted mix. If rebalancing your portfolio sounds like too much work, consider hiring a financial advisor or investing in a target date fund.