What does it mean to rebalance a portfolio?

 An Edward Jones financial advisor helps two clients balance their portfolio in his branch office.

It’s important to have a balanced portfolio – one that contains a mix of stocks, bonds, and other investments in proportions that reflect your individual comfort with risk, time horizon and long-term objectives. To maintain those proportions, you will need to periodically rebalance your portfolio.

Can my portfolio become out of balance even if I haven’t made any changes?

Yes. Suppose, for illustrative purposes, that your circumstances call for a portfolio consisting of 60% stocks and 40% bonds and other types of investments. After a long run-up in the stock market, however, stocks now make up 70% of the value of your portfolio – an amount that exceeds your comfort with risk. To get back to the 60% level, you may need to reduce your stock holdings and add to the other categories.

How often should I consider rebalancing?

As mentioned above, you may need to rebalance following a long upward movement of the markets. Conversely, if we experience a lengthy bear market, in which stock prices have dropped sharply, you may actually need to add to your stock holdings to get them up to your desired level. But in any case, you should review your portfolio at least once a year to see what adjustments you may need to make.

When should I change my desired portfolio balance?

Your desired portfolio balance, often referred to as asset allocation, should change at various points in your life. To illustrate: When you are younger, and have many years to go until you retire, you have time to overcome the short-term market volatility that’s an inevitable part of investing. Consequently, you can likely afford to have a higher percentage of stocks in your portfolio, knowing that stocks offer more growth potential than other investments. But once you’re retired, you may need to shift your focus somewhat from growth to income. Plus, you have fewer years to bounce back from volatile markets, and you don’t want to have to withdraw from your portfolio when your investments have lost value. So, when you retire, you may need to rebalance your portfolio toward more conservative, income-producing investments. (Keep in mind, though, that even during retirement, you will need to have some growth potential to help protect you from inflation; over time, even low inflation can deeply erode your purchasing power.)

How can I be prepared to rebalance when needed?

If your rebalancing requires you to add new investments, you’ll want to be prepared to act in a timely manner. That’s why it’s always a good idea to have enough cash on hand, to take advantage of investment opportunities.

Are there tax consequences to rebalancing?

It’s possible. If you need to rebalance by selling some investments that have gained in value, you might incur capital gains taxes, assuming the investments were held in a taxable account. So if you need to scale back in certain types of investments that you own in both taxable and tax-deferred accounts (such as your 401(k) and IRA), you may want to sell the investments in the tax-deferred accounts first. Transactions within your 401(k) and IRA will be free of capital gains taxes, although withdrawals from these accounts may be subject to regular income taxes. When you do start taking withdrawals, you’ll want to consult with your tax advisor.

You’ll always want your portfolio to be in proper equilibrium. An Edward Jones financial advisor can provide you with more information on rebalancing.