Article written by: Michael J. Dinan, CFP®
You have been working with your wealth advisor to establish a sound plan for your financial future. You have structured an investment portfolio with a risk level that matches your long-term goals. So now you can sit back and watch your portfolio grow, right? Not exactly. Just as important as establishing your risk level is the need to monitor your portfolio over time and ensure the asset allocation remains in-line with your long-term goals. One way to achieve this is by periodically rebalancing your portfolio.
In simple terms, rebalancing refers to the act of periodically buying or selling holdings in your portfolio to achieve or maintain a specific asset allocation. Your asset allocation is your desired mix of equity and fixed income that compliment your financial goals, time horizon, and risk tolerance.
Why is rebalancing important? Over time, your asset mix will fluctuate with the ups and downs of the financial markets. Unknowingly, the risk level in your portfolio may drift away from your target. For example, in a strong bull market, your equities may grow such that your portfolio includes more stock market risk than you intended. Conversely, in a down market, the value of your assets may fall, and some asset classes may be underweight. Rebalancing on a regular basis can help mitigate these unintended changes in your portfolio’s risk level.
For example, your financial goals, time horizon, and risk tolerance may lead you and your wealth advisor to implement a portfolio that is invested 50% in equities and 50% in bonds. After one year, your equities may have grown by 10%. Your portfolio is now allocated 60% in equities and 40% in bonds. This may have increased the risk profile of your portfolio to a level that isn’t consistent with your long-term financial goals. To rebalance your portfolio back to target, you would theoretically sell 10% in equities and buy 10% in bonds.
How often should you rebalance your portfolio? In a perfect world, with no transactions costs, the optimum policy would be to rebalance continuously. However, intermittent rebalancing is more practical. Every investor is unique, and no single rebalancing rule is best for all situations. You should rebalance frequently enough to ensure your risk level remains relatively consistent, but not so frequent that the benefits are overwhelmed by factors such as transaction costs and tax drag. Also, if your portfolio includes taxable accounts, it may result in realized gains subject to capital gains tax. Depending on your particular situation, you and your wealth advisor may decide on a rebalancing strategy that is sensitive to tax liability.
In summary, reviewing and rebalancing your portfolio periodically is one way to ensure your risk level remains aligned with your target asset allocation and financial goals. Working with a wealth advisor is key in not only determining, but also monitoring, your desired risk level over time. Should you have questions on your investment portfolio or wish to meet with one of our Wealth Advisors to discuss your particular situation, please contact our office.
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