Portfolio Rebalancing: When and How to Adjust Investments

Investing isn't as easy as just setting up a portfolio and forgetting about it until you retire. You should check in on your investments occasionally for some adjustments, which pros call portfolio rebalancing.  Rebalancing your portfolio means buying and selling assets to keep your investment risk at a level you're okay with. This not only helps you stay on track with your goals but might also boost your returns. So, whats portfolio rebalancing?

Its the process of tweaking your portfolio by buying and selling parts to get each asset class back to its original allocation.  You might need to rebalance now and then because the market value of each asset changes over time, throwing off your initial balance and potentially exposing you to more or less risk than you wanted. Rebalancing helps you get back to your desired allocation. If your investment strategy or risk tolerance has changed, you can use rebalancing to adjust the weight of each asset in your portfolio too.

The Functioning of Rebalancing

Its about adjusting the weight of asset classes to match your target allocation, usually by buying and selling assets. For example, if stocks do well and take up a bigger chunk of your portfolio than you planned, you might sell some stocks and buy other assets to get back to your target mix. Lets break it down with an example: Say you want 70% of your portfolio in stocks and 30% in bonds. Over time, market changes might push your portfolio to 80% stocks and 20% bonds if stocks perform well. To rebalance, youd sell some stocks and buy bonds to return to your original 70/30 split.

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Best Time to Rebalance

• Opt for Annual Rebalancing: A study found that not rebalancing or doing it less than every two years increased risk and volatility. Annual rebalancing is recommended for most investors.
• When there is more than a 5% shift in an asset: Some pros suggest rebalancing if a single assets performance shifts more than 5%. But dont overdo it; reacting to short-term movements can mean selling at a loss and missing out on potential gains.
• Year-end in December or during tax season in April: Many people rebalance while doing other financial tasks, like preparing taxes or using tax-loss harvesting to offset gains.

Remember, rebalancing isn't about overhauling your portfolio. Major changes should be rare and in response to big life events or shifts in goals. Its meant to keep your portfolio healthy, giving it room to grow while keeping an eye on its overall health. Portfolio rebalancing is all about getting your investments back to their original mix by buying and selling stuff. It's a simple idea but can get tricky in practice. When we talk about an investment portfolio, we're usually dealing with different accounts like IRAs, 401(k)s, brokerage accounts, and even some old paper bonds you forgot about. Each of these has its own tax rules. 

Strategies for Rebalancing

Keeping track of your investments helps you see the big financial picture more easily. But you don't have to be super organized to rebalance your portfolio. Here are some strategies you can use:

Large Cap Stocks Strategy

Most portfolios have a big chunk in U.S. large-cap stocks. These are stocks from companies valued at $10 billion or more. Any big changes in these can mess up your original allocation. The good news is, it's easy to spot what's off. If you see a major shift, check your large-cap stocks first and adjust as needed.

Treat Multiple Accounts with the Same Strategy

If you have multiple accounts with similar amounts, treat each one as a separate, balanced portfolio. Decide on your target asset mix and apply the same strategy to each account. You might not be able to invest in the exact same funds across different accounts, so look for ones with similar exposure or goals. Keep in mind the tax status and fees of each account to minimize costs.

Rebalancing the Main Account Strategy

If most of your retirement money is in one account like a 401(k) or an IRA, focus your rebalancing efforts there. It's easier and more impactful. Plus, if it's a tax-advantaged account, you won't have to worry about capital gains taxes when you sell within the account. Just don't ignore your smaller accounts entirely, especially if they have a lot of concentrated investments.

Rebalancing When Adding or Withdrawing Funds Strategy

Whenever you add new money to your accounts or withdraw funds, do a little rebalancing. Check which assets are over or underrepresented and adjust accordingly. You might not be able to do all the rebalancing at once, so combine this with other strategies.

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Rebalance with Robo-Advisors

Using a robo-advisor can make regular rebalancing a breeze. They do it automatically to keep you on track, though they usually charge a management fee, of around 0.25% per year. Some major brokerages let you do this yourself for free, but paying a small fee might be worth it for a hands-off approach. Plus, many robo-advisors offer tax-loss harvesting.

Reduce Your Taxes When Rebalancing

To keep taxes low when rebalancing in a brokerage account, try tax-loss harvesting or use new contributions to balance things out. You can avoid capital gains taxes by using new cash to buy assets that need more weight. You can also use dividends or interest payments for rebalancing. Selling assets at a loss can offset gains, reducing your tax liability. You might not eliminate capital gains taxes entirely, but these tips can help reduce them.

Conclusion

Rebalancing is key to managing your main and alternative investments. It keeps your risk level steady and could even boost your returns. Just be careful not to trigger too much taxable income when rebalancing in taxable accounts.

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