facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast blog search brokercheck brokercheck

Keep Your Investments on Track with Systematic Rebalancing

By Jane Young

In the current highly volatile economic climate, due to COVID-19, it is especially important to systematically rebalance your investment portfolio.  Rebalancing entails buying and selling stocks, bonds, and mutual funds to adjust your portfolio back to the target asset allocation. Your asset allocation is the primary determinant of your portfolio’s risk and return.

Before investing, every investor should define and document a target asset allocation for their portfolio. A target allocation is based on your investment goals, age, risk tolerance and investment timeframe.  The ideal asset allocation enables you to earn the highest return possible within the band of risk you are willing to assume.  Your asset allocation should identify the percentage you would like to keep invested in interest earning investments and equity (stock) investments.   Within the equity portion of your allocation you should also specify the amount you want to hold in large, medium, and small U.S. companies and how much you want in international companies.

You can systematically rebalance your portfolio on a set timeframe such as annually or semi-annually or you can rebalance based on thresholds.  For example, with a 5% threshold, if international stocks explode and the amount held in international stock exceeds your target allocation by more than 5%, you will rebalance back to your target.  There is no optimum timeframe or threshold for rebalancing but generally it is advisable to review your portfolio at least once a year.  If you rebalance too frequently you may overreact to short term fluctuations resulting in unnecessary transaction costs and taxes.

It is important to rebalance your portfolio to stay within the risk parameters you have specified in your asset allocation.  Rebalancing enforces a discipline to sell when prices are high and buy when prices are low.  You take some of the profit from stock in companies that are doing well and buy at a discount from companies that are struggling.  Rebalancing helps take the emotion out of your investment decisions.

Rebalancing is contrary to human nature; it feels counter intuitive to sell when the market is skyrocketing or to buy when the market has taken a significant dive.  This can make Investors reluctant to adjust their portfolio back to the target allocation.  There is a tendency to think “things are different this time”.   However, historical data indicates that investors who are willing to stick to their plan and systematically rebalance, even when the market has significantly dropped are rewarded in the long run.

When you rebalance your portfolio, start by reviewing and adjusting your target allocation based on changes to your liquidity needs, goals, financial situation, and risk tolerance.   When you rebalance, in addition to adjusting your portfolio to the target allocation, review the performance of the stocks, bonds and mutual funds in your portfolio.  Finally, when making the decision on which securities to buy and sell consider the tax ramifications.