I’m sure you started investing with a plan and a clear vision of how your money would grow. In fact, you carefully chose your mix of stocks, bonds, and maybe even ETFs. But fast forward a year or two, and things look different.
Some investments have surged ahead, others have lagged, and suddenly, your once-balanced portfolio feels a little off. This imbalance isn’t just a minor hiccup. It could mean unnecessary risks or missed opportunities for growth.
That’s where rebalancing comes in. In this blog, I’ll walk you through everything you need to know to rebalance your portfolio effectively and keep those gains rolling in.
What is Portfolio Rebalancing?
Portfolio rebalancing is the process of realigning the mix of assets in your investment portfolio. Over time, as the market fluctuates, the value of your investments will grow or shrink at different rates. This causes your portfolio’s asset allocation the percentage of stocks, bonds, ETFs, or other investments to drift from its original balance.
For example, say you initially allocated 60% of your portfolio to stocks and 40% to bonds. If your stocks perform exceptionally well, they might grow to represent 70% of your portfolio, leaving only 30% for bonds. While that growth sounds great, it also means you’re now taking on more risk than you originally intended.
Rebalancing brings your portfolio back to its original target allocation, ensuring you’re not overexposed to risk or missing out on potential gains from underrepresented assets.
Why Rebalancing Matters
If you’ve ever felt like your portfolio isn’t working as hard for you as it should, rebalancing could be the missing piece. Here’s why it’s so crucial:
- Risk Management: Markets are unpredictable. Without rebalancing, you could end up with a portfolio that’s too heavily weighted toward high-risk assets, exposing you to more volatility than you’re comfortable with.
- Maximizing Returns: Rebalancing helps you capture gains from overperforming assets while reinvesting in undervalued ones. It’s a way to buy low and sell high—a proven strategy for long-term success.
- Staying Aligned With Goals: Your financial goals and risk tolerance may change over time. Rebalancing ensures your portfolio remains aligned with your current objectives, whether you’re saving for retirement, a house, or something else entirely.
When Should You Rebalance Your Portfolio?
Timing is everything. Rebalancing too often can result in unnecessary fees and taxes while waiting too long can leave your portfolio out of sync. Here are three common approaches:
- Time-Based Rebalancing: This method involves rebalancing at regular intervals, such as quarterly, annually, or semi-annually. It’s simple and helps establish a routine.
- Threshold-Based Rebalancing: With this approach, you rebalance whenever your asset allocation drifts beyond a certain threshold, like 5% or 10%. For example, if your stocks grow to 70% of your portfolio when your target is 60%, it’s time to rebalance.
- Event-Based Rebalancing: Major life changes, such as getting married, starting a new job, or nearing retirement, may warrant a rebalancing to reflect your updated goals and risk tolerance.
Steps to Rebalance Your Stock Portfolio
Now that you understand the importance of rebalancing, let’s dive into the how-to part. Follow these steps to get your portfolio back on track:
1. Assess Your Current Portfolio
Start by reviewing your portfolio’s current allocation. Look at the percentages of stocks, bonds, ETFs, and other assets you own. Most investment platforms provide a visual breakdown, so it’s easy to see where you stand.
2. Set or Revisit Your Target Allocation
Revisit your financial goals and risk tolerance. Are you still comfortable with your original allocation? If not, adjust your target mix to better align with your current objectives. For instance, a young investor might lean toward a 70/30 stock-to-bond ratio, while someone nearing retirement might prefer a 50/50 split.
3. Identify Assets to Buy or Sell
Once you know your target allocation, identify which assets to sell and which to buy. For example, if stocks are overweighted, sell a portion of your stocks and use the proceeds to buy more bonds or other underweighted assets.
4. Consider Taxes and Fees
Before making any trades, take a moment to assess the potential costs. Selling assets in a taxable account could trigger capital gains taxes, so plan your moves carefully.
Common Mistakes to Avoid
Even with the best intentions, it’s easy to make mistakes while rebalancing. Avoid these pitfalls to ensure you’re getting the most out of your efforts:
- Rebalancing Too Often: Frequent trades can rack up fees and taxes, eating into your gains. Stick to a regular schedule or threshold to avoid overdoing it.
- Ignoring Costs: Always factor in fees, taxes, and bid-ask spreads when buying or selling assets. These can significantly impact your returns over time.
- Letting Emotions Drive Decisions: The market can be unpredictable, but emotional decision-making often leads to poor outcomes. Stick to your plan and avoid impulsive moves.
Read Also: All You Need to Know About an Investment Portfolio
Conclusion
Rebalancing your stock portfolio isn’t just a “set it and forget it” task; it’s a critical step in achieving long-term financial success. By keeping your asset allocation in check, you manage risk, maximize returns, and stay aligned with your goals.
So, what are you waiting for? Take a moment today to review your portfolio and see if it’s time for a tune-up.
