Here’s When (and How) to Balance Your Investment Portfolio
If you were hoping for a one-size-fits-all answer to the question of when is the best time to rebalance your portfolio, I’m sorry to disappoint: Portfolio rebalancing is one of the most important, yet debated, aspects of investment management. While the concept is simple—getting your investment portfolio back to its target allocation—the timing and frequency of rebalancing can spark heated debate among financial experts. Let’s look at the different approaches and determine which one might make sense for you.
Understanding Portfolio Drift
Over time, your investment portfolio will naturally deviate from your original allocation as different assets perform differently. For example, during a bull market, your stock allocation could rise significantly more than your bond allocation, potentially exposing you to more risk than you originally thought. Conversely, during market downturns, your exposure to stocks may decline, which may make your portfolio too conservative for your goals.
Different Approaches to Rebalancing
The main goal of rebalancing your portfolio is not so much to increase returns, but to reduce risk. With that in mind, here are some ways to focus your rebalancing efforts.
Calendar approach
Many financial experts advocate a simple calendar-based rebalancing strategy, usually annually or semi-annually. This approach has a number of advantages:
-
Requires minimal time and attention
-
This helps maintain discipline in your investment strategy.
-
This reduces the likelihood of impulsive changes during market volatility.
Threshold approach
Others prefer threshold-based rebalancing, triggering adjustments when asset allocation falls outside a certain percentage (often 5% or more) of targets. This method:
-
Reacts more dynamically to market movements.
-
Can use more opportunities to rebalance
-
Potentially can improve returns in volatile markets.
When you might not have to worry
Successful rebalancing begins first with a well-thought-out asset allocation strategy. Your allocation should reflect your risk tolerance, investment schedule, financial goals and income needs. Certain investment vehicles and situations minimize the need for active rebalancing:
-
Target date funds : These automatically rebalance and adjust your asset allocation as you get closer to retirement.
-
Robo-advisors : These digital platforms typically automatically perform rebalancing based on predetermined parameters.
-
Professionally managed accounts . If you work with a financial advisor, they usually do rebalancing as part of their services.
So instead of strictly adhering to time-based or threshold-based rebalancing, simply review your portfolio at least once a year, but avoid getting caught up in minor fluctuations. Consider rebalancing when your allocation deviates significantly (5% or more) from your targets, especially if you are approaching retirement or have a lower risk tolerance.
A few other tips to keep in mind: Use new contributions to rebalance whenever possible, as this can minimize transaction costs and tax consequences. And don’t forget the tax implications—rebalancing into tax-advantaged accounts like 401(k)s and IRAs can help you avoid capital gains taxes .
Bottom line
The best rebalancing strategy is the one you actually follow. While the debate between time-based and threshold-based rebalancing continues, the most important factors are understanding your investment goals and risk tolerance. Maintain a consistent approach and avoid emotional decisions during market volatility.
Whether you choose annual rebalancing or a threshold approach, the key is to stick to your long-term investment plan while making sure your portfolio doesn’t stray too far from your intended asset allocation. Remember that the goal of rebalancing is not to maximize profits, but to maintain a risk-return ratio that is consistent with your investment goals.