Is it Time to Rebalance Your Portfolio?

Every investor wants to buy low and sell high. What if we told you there is a disciplined process for doing just that, and staying on track toward your personal goals while you're at it? There is, and it's called rebalancing.

Here's how it works. Imagine it's your first day as an investor. As you create your new portfolio, you've got a plan to put a portion of your assets in stock, a portion in bonds, and so on. Assigning these weights is called asset allocation.

Then time passes. Because markets don't move in tandem, your investments stray from the original allocations. Even if you've done nothing, market shifts mean you're now taking on higher or lower risks and expected rewards than you intended. Unless your plans have changed, your portfolio needs some attention. This is what rebalancing is for: to shift your assets back to their intended, long-term allocations.

A Rebalancing Illustration
Suppose you and your advisor have planned for your portfolio to be exposed to stocks and bonds in a 50/50 mix. If stocks outperform bonds, you can end up too heavily weighted toward stocks relative to bonds, until you're no longer at your intended blend. To rebalance your portfolio, you can sell some of the now-overweight stocks and use the proceeds to buy bonds that have become under-represented, until you're back at or near your desired mix. Another strategy is to use any new money you are adding to your portfolio to buy more of whatever is underweight at the time.

By rebalancing, not only are you keeping your portfolio on track toward your goals, but you're buying low (underweight holdings) and selling high (overweight holdings). Trades are driven by market evidence, not random guesswork or emotional reactions. Your carefully crafted, customized plan is working.

A Closer Look
That's a simple illustration, but in reality, rebalancing is more complicated, because asset allocation occurs on several levels. First, we suggest balancing stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns. Then we typically divide these assets among stock and bond subcategories, again according to your unique financial goals. For example, you can assign percentages of your stocks to small vs. large companies and value vs. growth firms, and further divide these among international, U.S., and emerging markets.

These relatively precise allocations can help you maximize exposure to the right amount of expected market premiums for your personal goals. At the same time, you minimize the market risks involved by diversifying those risks around the globe and across markets. We and the fund managers we typically turn to for building our portfolios are guided by these tenets of evidence-based investing.

Striking a Balance in Rebalancing
Rebalancing using evidence-based investment strategies is integral to helping you succeed as an investor. But like any power tool, it should be used with care and understanding.

It's scary to do in real time. Everyone understands the logic of buying low and selling high. But when it's time to rebalance, your emotions make it easier said than done. Bad times in the market can represent good times for rebalancing. But that means you must sell some of your assets that have been doing okay and buy the unpopular ones. By the same token, an exuberant market can be another rebalancing opportunity – and another challenge – as you must sell some of your high flyers (selling high) and rebalance into the lonesome losers (buying low).

Costs must be considered. If trading were free, you could rebalance your portfolio daily with precision. In reality, trading incurs fees and potential tax liabilities. To achieve a reasonable middle ground, it's best to have guidelines for when and how to cost-effectively rebalance. If you'd like to know more, we're happy to discuss the guidelines we employ for our own rebalancing strategies.

Rebalancing using evidence-based investment strategies makes a great deal of sense once you understand the basics. It offers objective guidelines and a clear process to help you remain on course toward your personal goals in rocky markets. It ensures you are buying low and selling high along the way. What's not to like about that?

At the same time, rebalancing requires informed management to ensure changes are integrated consistently and cost effectively. An advisor can help you prevent emotion from interfering with reason as you implement a rebalancing plan. Helping clients periodically employ efficient portfolio rebalancing is another way Align Wealth Management seeks to add value to your investment experience.