Rebalancing Your Portfolio

It’s a good idea to periodically check the allocation of your investment portfolio to ensure it accurately reflects your objectives and risk tolerance levels. This is especially true during periods of time when the market is experiencing high volatility levels.  As market performance alters the values of your asset classes, you may find that your asset allocation no longer provides the balance of growth and income to potentially achieve the level of return that you want. In that case, you may want to consider adjusting your holdings and rebalancing your portfolio.

Assets grow at different rates—which means that your portfolio might end up out of line with the target allocation you have chosen. For example, some assets might recently have grown at a much faster rate, or perhaps a market correction has driven a certain part of your portfolio lower in the short term. To compensate, you might reallocate some of the value of fast-growing assets into assets with slower recent growth, which may now be poised to pick up steam while recent high-performers slow down. Otherwise, you might end up with a portfolio that carries more risk and provides a lower long-term return than you intended.

There’s no official timeline that determines when you should rebalance your portfolio. If you are a more active investor, or during periods of high volatility, you might decide a quarterly re-balancing schedule is appropriate. Perhaps if you are a less active investor you may consider assessing whether you need to rebalance once a year as part of an annual review of your investments. The most important point is this – you should regularly examine the allocation of the portfolio to determine if it still reflects your long-term goals.

The Cost of Re-Balancing

Keep in mind that account re-balancing could mean potential tax implications and maybe even other fees. Aside from the costs you might incur, switching out of investments that have appreciated could mean recognizing a capital gain, or selling an asset that has performed poorly means locking in your loss. If selling an appreciated holding occurs in a taxable account, you could incur a tax, but you may be able to offset some or all of that with a tax deduction by selling assets that have declined. However, if you are rebalancing in a retirement savings account like and IRA or 401(k), you can’t take a tax deduction on capital losses. If you aren’t versed in this process, its best to seek the advice of financial professional.

Rebalancing Approaches

You can rebalance your portfolio in different ways to bring it back in line with the allocation  you intend it to have. Here are three common approaches to rebalancing:

1. Redirect money to the lagging asset classes until they return to the percentage of your total portfolio that they held in your original allocation.
2. Add new investments to the lagging asset classes, concentrating a larger percentage of your contributions on those classes.
3. Sell off a portion of your holdings within the asset classes that are outperforming others. You may then reinvest the profits in the lagging asset classes.

All three approaches work well, but some people are more comfortable with the first two alternatives than the third. Psychologically they find it hard to sell off investments that are doing well in order to put money into those that aren’t. Remember, though, that if you invest in the lagging classes, you’ll be positioned to potentially benefit if they turn around and begin to prosper again.

Automatic Rebalancing with Lifecycle Funds

The asset allocation you choose to help you meet your financial goals at an earlier time in life may no longer be the ideal allocation after you’ve been investing for some time, for instance as you approach retirement.

Often too many investors simply never take the time to modify their portfolio allocations. Some may not feel confident doing so, or they simply get too busy and neglect a regular analysis of their investments. The result is they end up doing nothing.

That’s where lifecycle funds, also called target date funds, come in. These funds are increasingly being offered in retirement plans, and are also available to investors outside of retirement plans, too. Each lifecycle fund is designed to have its asset allocation modified gradually over a period of years, shifting its focus from seeking growth to providing income and preserving principal.

Usually, this is accomplished by reducing your exposure to stocks and increasing the percentage your lifecycle fund allocates to bonds. To make matters simpler, a fund’s timeframe is often part of its name. So, in 2015, if you’re thinking of retiring in about 15 years, you might put money into Fund 2030. And if your target retirement date is 30 years away, you might choose Fund 2045. In theory, this is a good idea to help those investors who might be less willing, or able, to adjust their portfolio allocation themselves. However, the caveat in the current environment is this – in a time period when the equity market is weak, and interest rates are rising, you could experience short term losses in both asset classes as the fund regularly re-balances. Before transferring your balances to a lifecycle fund, you’ll want to investigate the fund as you would any potential investment, looking at its objective, fees, manager, historical performance and risk levels, among other details

Source: FINRA