How to Rebalance Your Portfolio (and Why It Matters)

Your investment portfolio should be a mix of different asset classes that reflect your tolerance for risk. However, fluctuations in the market can cause that mix to drift — which can impact your strategy for reaching your goals and the riskiness in your portfolio. Rebalancing your portfolio realigns these assets to your intended levels.

Portfolio rebalancing is one of the more effective ways to stay on track to reach your investment goals. Not only does it help keep your portfolio aligned with your risk tolerance, it also gives you the opportunity to lock in gains from one asset class and redeploy them to asset classes that have become relatively inexpensive. These regular tactical changes take advantage of shorter-term opportunities without losing sight of the long-term strategic allocation.

Why Is It Important to Have a Balanced Portfolio?

Having a diversity in asset classes (stocks, bonds, real estate, precious metals) and also diversity within asset classes helps balance risk and ensure that you’re getting the returns you anticipated. A balanced portfolio helps protect you from volatility and ensures that you don’t put all your eggs in one basket.

Building a diversified portfolio gives you a strong foundation, but you need to revisit your asset mix regularly to offset asset mix drift. For example, you have invested in stock X, which has recently increased in value significantly. That stock now makes up a larger percentage of your portfolio than you had planned. If stock X suffers a sudden downturn, you could experience a more significant loss than you are willing to take on. Rebalancing investments allows you to stabilize your portfolio so you can continue to build toward your goals.

How Often Should I Rebalance My Portfolio?

If your portfolio includes anything other than target date funds (which automatically rebalance) or is not professionally managed, you should rebalance regularly. There is debate about how often, but once a year or when your asset mix drifts more than a few percentage points off of your intended balance is a good baseline.

If you have taxable non-retirement investments, you may want to rebalance at the end of the year to take advantage of tax-loss harvesting. If your accounts are non-taxable (like most retirement accounts) it doesn’t matter when in the year you rebalance.

How Do I Rebalance My Portfolio?

The best way to start is to review your ideal situation, taking into account your preferred level of risk. Your risk tolerance is impacted by your current financial situation, your goals, your timeline, and your personal approach to investing so if any of those have changed significantly you should meet with your financial advisor to evaluate your strategy. 

Most accounts will include a breakdown of your current asset mix. Now that you know what your ideal mix is, look at your portfolio’s current allocation and compare that to the ideal, as well as the room for error percentage that you set. For example, if your ideal is 70% of your portfolio invested in stocks and it is currently at 71%, rebalancing may not be necessary. However, if it’s at 75% stocks, perhaps you are no longer comfortable with the increased risk. If you have multiple accounts, you should look at all of your accounts as a whole to determine what changes need to be made to your overall investment portfolio rather than looking at each account individually.

There are two ways to rebalance: You can buy and sell assets or you can deploy dollars to bring your asset mix back to your ideal:

Buy and sell is exactly what it sounds like: You sell off investments that are over-weighted in your portfolio and use that money to buy assets in other classes. This may seem counterintuitive because you’re selling off asset classes that are currently doing well. However, the long-term success of your portfolio depends on keeping your asset mix (and risk level) at your preferred level. In addition, you are essentially selling high, so as long as you bought the asset for a lower price you have earned a return on that investment regardless of future movement.

Deploying new dollars can help avoid transaction fees that may occur when you buy and sell assets. The idea is to invest new money in underperforming categories; this allows you to adjust to your ideal asset mix without selling off high performers or incurring transaction fees. This requires either an influx of cash or patience as you reallocate your regular deposits to other assets.

Rebalancing can be difficult and time-consuming but it also allows you to take a deep look at your investment portfolio. If you’re looking for professional help as you manage your investments and work toward your financial goals, talk to a Farm Bureau financial advisor.