There is a relatively underused and simple technique to raise your long-term portfolio performance and reduce your risk at the same time. It’s called “rebalancing,” and it’s something every investor can and should do.
Let’s start with the basics. First, to rebalance, you need to have more than one investment in your portfolio (so you can hold investments in different asset classes, like stocks, bonds, and cash). Second, you need to determine the right mix of those investments for your objectives.
For example, an aggressive investor with a long time horizon might invest 80% of her portfolio in stocks, 15% in bonds, and 5% in cash. On the other hand, a conservative investor might hold 30% in stocks, 60% in bonds, and 10% in cash.
The opportunity for rebalancing arises when the market performance of your investments changes their value and, as a result, their weighting in your portfolio.
How Rebalancing Is Done
The purpose of rebalancing is to restore an investor’s portfolio to the structure that fits his/her objectives. Here’s how you do it: you sell off a portion of any asset class that has increased beyond its target percentage and reinvest the sale proceeds in more of asset classes that have shrunk below their target percentage.
The calculation is simple: multiply the new market value of your portfolio by your target mix percentages and compare them to the values in your account.
Aside from maintaining the level of investment risk that’s right for you, rebalancing has two additional benefits.
First, it forces you to lock in your gains, which many investors fail to do. Second, rebalancing can add as much as one-half percent or more to your long-term investment returns. That may not sound like much, but over 20 years, it could mean thousands of dollars more in your pocket.
How Often Should You Rebalance?
A good rule of thumb for rebalancing is once a year. But, depending on market performance, it could be more or less often than that. The best advice is to check your portfolio several times a year and rebalance whenever there have been significant changes in the weighting of its constituent parts.
This is just an overview of rebalancing. It can apply not only to asset classes, but to subasset classes as well.
For example, your asset allocation strategy may call for specific exposure to large and small-cap stocks or U.S. and foreign stocks, while your bond portfolio may include Treasuries and investment-grade corporate or high-yield bonds, and changes in their weighting may suggest you rebalance among these, too. There’s also the question of which particular stocks or bonds you sell or buy.
Finally, there’s always the chance that changes in your portfolio may coincide with changes in your objectives – you may actually need to be taking more or less risk than in the past.
Whether and when to rebalance is just one of many considerations that are important to maintaining your investment portfolio. Please call if you’d like to discuss this in more detail or would like to review your overall investment portfolio.
Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.