What is portfolio rebalancing?
Portfolio rebalancing is the process of buying and selling assets until a portfolio reaches a strategic balance. 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 other asset classes.
How to rebalance a portfolio
You can rebalance your portfolio by selling and purchasing assets until they meet your original balance. While rebalancing is straightforward, when you rebalance a portfolio depends on a variety of factors.
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.
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 to better align with your retirement goals.
How can I be prepared to rebalance when needed?
Your portfolio was designed to help meet long-term goals, and it’s important that your allocation still aligns with these goals to keep you on track. Develop a strategy with your financial advisor to review your portfolio’s asset allocation on a regular basis and rebalance when appropriate.
Portfolio rebalancing hypothetical example
Imagine you have a portfolio worth $100,000 with the following allocation:
- 60% stocks ($60,000)
- 30% bonds ($30,000)
- 10% cash ($10,000)
Over time, the assets change in value as follows:
- Stocks: $75,000
- Bonds: $35,000
- Cash: $10,000 (doesn't grow in the account)
Based off the new total portfolio value of $120,000, this portfolio would be 62.5% stocks, 29.2% bonds and 8.3% cash, which doesn’t match the original balance.
By selling $3,000 in stocks, purchasing an additional $1,000 in bonds and saving the remaining $2,000 in cash, the portfolio would be rebalanced to the original 60/30/10 ratio.
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.
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.
Portfolio rebalancing FAQs
Does rebalancing really pay off?
Portfolio rebalancing can pay off for investors when done correctly. By rebalancing, an investor can actively manage risk tolerance. If you're unsure how to rebalance your portfolio, consider contacting a financial advisor.
What are the downsides of rebalancing?
Rebalancing a portfolio can come with a few downsides apart from potential taxes. For example, broker fees might be charged for every trade or transaction you make. Rebalancing could also minimize the impact of compounding gains in some assets. However, rebalancing can be worth it for many investors looking to mitigate risk caused by overexposure to certain assets or sectors.
Does it cost money to rebalance a portfolio?
Rebalancing can cost money if your broker charges fees or if you owe taxes due to capital gains (assuming the rebalancing occurs in a taxable account). Generally speaking, rebalancing can be done for a relatively small cost, or no cost at all.