Table of Contents
- What is Investment Portfolio Rebalancing?
- The Benefits of Investment Portfolio Rebalancing
- When to Rebalance Your Investment Portfolio
- How to Rebalance Your Investment Portfolio
- Tools to Help You Rebalance Your Investment Portfolio
- Conclusion
Investment Portfolio Rebalancing: What It Is and Why You Need It
Investing in the stock market is not a one-and-done activity. It’s important to monitor your investment portfolio regularly and make adjustments as needed. Rebalancing your investment portfolio is an essential step in ensuring that your investment strategy continues to align with your financial goals. In this article, we’ll explore what investment portfolio rebalancing is, its benefits, and how to do it effectively.
What is Investment Portfolio Rebalancing?
Investment portfolio rebalancing is the process of adjusting the proportion of each asset in your investment portfolio to maintain a certain level of risk and return. Over time, your investment portfolio may grow or shrink due to market fluctuations, stock dividends, and other factors. As a result, the original asset allocation that you designed may no longer be optimal. Rebalancing your portfolio helps you get back to your original asset allocation and maintain the risk level that you’re comfortable with.
The Benefits of Investment Portfolio Rebalancing
There are several benefits to investment portfolio rebalancing. Here are some of the key advantages:
Maintains the Risk and Return Profile of Your Portfolio
One of the main benefits of rebalancing your investment portfolio is that it helps you maintain the risk and return profile of your portfolio. When you first design your portfolio, you allocate a certain percentage to each asset class based on your risk tolerance and financial goals. Over time, as some assets perform better than others, the proportions of your portfolio can shift. Rebalancing helps you restore the original allocation and ensure that your portfolio continues to meet your risk and return objectives.
Reduces the Risk of Overconcentration
Another benefit of rebalancing your investment portfolio is that it helps reduce the risk of overconcentration. If one asset class in your portfolio outperforms the others, it can lead to overconcentration and increase the risk of your portfolio. By rebalancing, you can reduce the exposure to over performing assets and reinvest the proceeds in underperforming assets to rebalance the portfolio.
Forces You to Sell High and Buy Low
Rebalancing your portfolio forces you to sell high and buy low. When one asset class outperforms the others, you’re essentially selling it at a high price and buying the underperforming asset at a lower price. This is a basic principle of investing and can lead to better returns over the long run.
Helps You Stay Disciplined
Finally, rebalancing your investment portfolio helps you stay disciplined. It forces you to review your portfolio regularly and make adjustments as needed. This can help you avoid emotional decision-making and ensure that you stay on track to achieve your financial goals.
When to Rebalance Your Investment Portfolio
There isn’t a one-size-fits-all answer to when you should rebalance your investment portfolio. However, there are a few key scenarios where it’s a good idea to consider rebalancing your portfolio:
When Your Asset Allocation Deviates Significantly from Your Target
The most common scenario for rebalancing is when your asset allocation deviates significantly from your target allocation. For example, if your target allocation is 60% stocks and 40% bonds, but due to market fluctuations, your portfolio is now 70% stocks and 30% bonds, then it’s time to rebalance.
Annually
Rebalancing your investment portfolio annually is a good rule of thumb for many investors. It’s a simple way to ensure that your portfolio stays aligned with your financial goals and investment strategy.
As You Approach Retirement
As you get closer to retirement, it’s a good idea to start rebalancing your portfolio to reduce the risk level. Many financial advisors recommend gradually shifting your portfolio from stocks to bonds as you approach retirement to reduce the risk of a market downturn.
How to Rebalance Your Investment Portfolio
Rebalancing your investment portfolio is a relatively simple process. Here are the steps that you can follow:
Review Your Current Portfolio
The first step in rebalancing your portfolio is to review your current portfolio and identify how it has deviated from your target asset allocation.
Determine Your Target Asset Allocation
Next, you’ll need to determine your target asset allocation based on your financial goals and risk tolerance. This will help guide your rebalancing strategy.
Sell Overperforming Assets
After you’ve identified the overperforming assets in your portfolio, it’s time to sell them. This will help you reduce your exposure to the assets that have exceeded their target allocation.
Buy Underperforming Assets
Finally, you’ll want to use the proceeds from selling overperforming assets to buy underperforming assets. This will help you rebalance your portfolio and restore your target allocation.
Tools to Help You Rebalance Your Investment Portfolio
There are several tools and resources that can help you rebalance your investment portfolio effectively. Here are a few examples:
Robo-Advisors
Robo-advisors are an increasingly popular option for investors who want a hands-off approach to portfolio management. Many robo-advisors offer automatic rebalancing as part of their services, making it easy to maintain your target asset allocation.
Portfolio Rebalancing Software
There are several portfolio rebalancing software options available that can help you rebalance your portfolio. These tools can help you analyze your portfolio, identify over- and under-performing assets, and determine the optimal target allocation.
Financial Advisor
Finally, if you have a financial advisor, they can help you with portfolio rebalancing. They can provide guidance on when and how to rebalance your portfolio based on your financial goals, risk tolerance, and overall investment strategy.
Conclusion
Investment portfolio rebalancing is an essential step in maintaining your investment strategy and achieving your financial goals. By rebalancing your portfolio, you can maintain your target asset allocation, reduce the risk of overconcentration, and avoid emotional decision-making. If you’re not sure how to rebalance your investment portfolio, consider using one of the many tools and resources available or consult with a financial advisor to get started.
