Raleigh NC Financial Advisor: Rebalancing Your Portfolio & 401k
How to bring your portfolio back in line with your goals
Your investment portfolio is more than the sum of your account balances. It represents your pathway toward important financial goals, whether a comfortable retirement or a college education for your kids.
But over time, the inevitable ups and downs of the financial markets can change the profile of your investment plan, leaving you with more risk than you’d like or less growth potential than you need. Fortunately, a strategy called rebalancing can help keep your investment plan in line with your goals.
What is rebalancing?
The centerpiece of your investment plan is your asset allocation—the mix of stocks, bonds and cash in your portfolio. The allocation you choose depends on your situation. If you’re decades away from retirement, you may want to allocate more of your portfolio to higher-risk investments such as stocks, which offer more growth potential than conservative investments such as bonds or cash. By contrast, if you just have a few years before retirement, you may want more exposure to those less-risky investments.
But while your target allocation stays constant, your actual asset allocation does not. The market’s ups and downs may cause that allocation to drift as your investments change in value. For example, a sustained stock market rally can boost the value of your stock holdings, tilting the balance of your asset allocation toward stocks and exposing you to more risk than you intended.
Regular rebalancing strategies can help bring your asset allocation back in line with your target allocation—regardless of the market’s ups and downs. What’s more, setting regular portfolio reviews means you’re less likely to make spur-of-the-moment decisions that can negatively impact your financial plan.
How does it work?
There are two main methods for when to rebalance your portfolio: periodic rebalancing and “tolerance band” rebalancing. Each can be an effective tool to manage your investments and limit your exposure to undesirable risks. Whichever method you choose, the important thing about rebalancing your portfolio is not necessarily how you do it, but your commitment to sticking with it.
Periodic rebalancing. The periodic rebalancing approach is relatively simple, requiring little monitoring and oversight.
To use this method, mark a recurring date on your calendar when you’ll analyze your investment holdings and adjust allocations if necessary. You may choose to do this annually, every six months or every quarter—it’s up to you. To make it easy on yourself, consider pegging the date you choose to another easy-to-remember date, like tax day or the end of a quarter. One note: Reviewing and rebalancing your portfolio too often can potentially be counterproductive.
Tolerance band rebalancing. Tolerance band rebalancing is a bit more intensive than periodic rebalancing. It requires a formulaic approach that demands frequent monitoring. Instead of choosing a set time to rebalance, you do so when your asset allocation changes by a specific percentage, or threshold of change.
For example, say your threshold of change is 5%, and your target allocation of stocks is 70%. You would rebalance your stock allocation when it shifts either up to 75% percent or down to 65%. This method is useful in helping you make sound investment decisions in a rapidly changing market.
However, it can also be more expensive than period rebalancing. During times of volatility, you may end up buying and selling investments more frequently and potentially paying more in trading costs.
If your review identifies a need to rebalance, here are a couple of ways to bring your portfolio back in line: The first option is to sell investments to assets with a higher allocation and use the proceeds to invest in assets with lower allocations. Or you can simply direct new investments to those assets with low allocations to bring them back in line with your target.
Make adjustments as your goals change
Life events, like the birth of a child, marriage, divorce or a death in the family can change your investment goals and time horizon. When these events happen you may want to rebalance your portfolio, even if you’re not technically scheduled to do so. Make your adjustments and continue to use the method of monitoring that works best for you.
Rebalancing your 401(k)
Rebalancing your 401(k) is an important step in managing your retirement savings.
Here are a few reasons why rebalancing your 401(k)is important:
Maintaining your asset allocation: Over time, the value of different investments in your portfolio will grow at different rates. This can cause your portfolio to become unbalanced, meaning that the percentage of your portfolio invested in each asset class is no longer aligned with your original investment strategy. Rebalancing helps you maintain your desired asset allocation and can help reduce risk in your portfolio.
Minimizing risk: Different asset classes have different levels of risk. Rebalancing can help you adjust the mix of investments in your portfolio to better match your risk tolerance and investment goals. For example, if you're nearing retirement and want to reduce your exposure to risky assets like stocks, rebalancing can help you shift more of your portfolio into less risky investments like bonds.
Maximizing returns: Rebalancing your 401(k) can help you maximize your returns by taking advantage of market trends. For example, if stocks have been performing well and are a larger percentage of your portfolio than you originally intended, rebalancing can help you sell some of your stock holdings and buy more of the asset classes that have been underperforming.
Overall, rebalancing your 401(k) is an important part of managing your retirement savings and can help you maintain the right mix of investments to meet your financial goals.
The Bottom Line
Regularly rebalancing your portfolio can help ensure you maintain an investment strategy that is in line with your goals and risk tolerance. By rebalancing, you can ensure you are not too heavily invested in any one asset class and are taking advantage of any market fluctuations that may have occurred since you first allocated your investments.
Rebalancing also helps you stay focused on the long-term objectives of your portfolio and not be influenced by short-term market movements. As such, regularly rebalancing your portfolio can help keep your eye on the big picture and keep your investments in line with your goals and risk tolerance.
Sources:
https://www.morningstar.com/articles/962396/heres-why-you-should-rebalance
https://www.vanguard.com/pdf/ISGPORE.pdf
https://investor.vanguard.com/investing/portfolio-management/rebalance
https://www.finra.org/investors/learn-to-invest/key-investing-concepts/rebalancing-your-portfolio
Disclosures:
This site may contain links to articles or other information that may be on a third-party website. Advisory Services Network, LLC is not responsible for and does not control, adopt, or endorse any content contained on any third-party website.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.
