A Comprehensive Guide
Portfolio rebalancing is something we tend to forget about, but it is an important part of portfolio management. When you first invested with Brown and Company you may have had a specific goal in mind or a certain timeline to invest.
Over time things change. You may have gotten married, divorced, bought a home, had a child, or experienced a job loss. These life events affect your portfolio, diversification, and life goals. The investment environment also changes. Your portfolio’s investments may have strayed from your initial asset allocation you decided upon with your Brown and Company financial advisor. Your risk tolerance may also have changed. This is why regularly rebalancing your portfolio is essential.
What Does It Mean to Rebalance a Portfolio?
So, what is portfolio rebalancing? It is a reevaluation of your investing goals, risk tolerance, and rebalancing strategy. Rebalancing seeks to align your portfolio investments to your desired allocation and investing time horizon. Over time portfolios may drift from your original goals. Perhaps, you originally wanted to invest 60% in stocks and 40% in bonds. Due to reinvestment of dividends and capital gains, your portfolio may now be 80% in stocks and 20% in bonds. This investment drift needs to be reevaluated, along with your current financial situation and investment horizon.
Markets are always changing and your risk tolerance to these market fluctuations may have changed as well. You may now prefer a portfolio that is less stocks and more bonds. This means your rebalancing strategy will need to be changed. You will also need to reexamine your portfolio’s asset allocation and diversification.
Portfolio rebalancing takes into consideration these changes.
A rebalancing strategy is key to ensure you are rebalancing your portfolio correctly. Rebalancing should be viewed as a discipline and not an attempt to time the market. The first step is speaking with your financial advisor at Brown and Company.
Why Rebalancing Frequency Matters
So, how often should you rebalance your portfolio? Rebalancing frequency is important, along with maintaining a disciplined approach. Scheduling a portfolio review with your financial advisor at Brown and Company is the first step. Our investment planning services can help you find the appropriate portfolio rebalancing cadence, whether that is quarterly, semi-annually, or an annual rebalancing.
Finding the right rebalancing frequency is important, as this will help keep you on target towards your investing goals. Rebalancing helps you match your portfolio to your personal risk tolerance. This is important, as your goals and investment timeline may have changed due to life events. Portfolio rebalancing is similar to a wellness checkup. It is a healthy way that aims to ensure your portfolio is performing at its best.
When you speak with your Brown and Company financial advisor you will work together to find a rebalancing strategy that works for you. You want to make sure you are not over-rebalancing or under-rebalancing as each has specific risks.
If you rebalance too frequently you may incur unnecessary tax consequences. This can reduce the overall returns of your portfolio. If you do not perform at least an annual rebalancing of your portfolio you may find your asset allocation and investment diversification does not align with your risk tolerance and investing goals. This means you may be taking on too much or too little risk in your portfolio. This can undercut your overall long-term returns.
Portfolio rebalancing on a consistent basis will help you to pursue your financial goals and will also help to remove any emotion out of the market ups and downs. Investing involves dealing with market volatility and suppressing emotional reactions to market events.
Brown and Company can help you develop a rebalancing strategy, along with our personalized investment planning, to help you develop a disciplined approach to investing. Regularly rebalancing your portfolio helps to discipline your investing by removing the emotion out of trying to time the market. This will lead to better success in working towards your financial goals.
Common Rebalancing Schedules Investors Use
Your financial advisor will help you develop a rebalancing strategy that best fits your future goals and investing timeline. This is part of Brown and Company’s overall investment planning strategy that we develop with you. There is no “one-size-fits-all” to portfolio rebalancing.
Your financial advisor may guide you to a time-based rebalancing strategy. This sets up a time during the year, such as quarterly, semi-annually, or annually, when you will meet with your advisor to review and rebalance your portfolio. This is one of the most common methods to use for portfolio rebalancing management.
The threshold-based approach is another rebalancing strategy, which creates defined preset thresholds aligned with your portfolio’s asset allocation. When these thresholds rise or fall past the set targets the portfolio is rebalanced.
Threshold-based investing is a bit more complex and should be discussed in detail with your financial advisor. What is critical is developing a dialogue with your financial advisor so they can get to know you and your personal needs. This way a plan created just for you can be developed.
Time-Based Rebalancing vs. Threshold-Based Rebalancing
A time-based rebalancing of your portfolio, such as an annual rebalancing, is generally found by many clients to be more effective, as it is much simpler. A portfolio rebalancing occurs at set intervals: quarterly, semi-annually, or annually. At each time-based period the portfolio’s asset allocation and diversification are reviewed and realigned with your goals. This rebalancing strategy also creates a good forum for you to regularly meet and check in with your Brown and Company financial advisor to discuss any life changes and your financial situation.
A threshold-based rebalancing is more complex and precise, as it sets defined parameters you and your financial advisor decided upon for your portfolio’s asset allocation and diversification. This method may require daily monitoring, but by using advanced software many trades can be initiated when the thresholds are met.
For example, you can specify certain allocations you want for different market sectors in your portfolio, such as 20% in industrials, 40% in technology, and 40% in real estate. When any of these allocations drift by more than ±5% a trade can be made to buy or sell the stocks or mutual funds in the portfolio to align with your preset thresholds. The portfolio is then rebalanced. This threshold rebalancing can be set to match certain indexes, market sectors, and predefined allocations. The purpose is to realign your portfolio back to your original decided upon asset allocation.
How Market Volatility Should (and Shouldn’t) Affect Rebalancing
Managing portfolio decisions during market volatility is an inherent part of investing. As an investor you should get used to the ups and downs of markets. You should never let market swings distract you from your investing goals. Maintaining a regular schedule of rebalancing your portfolio will help you to better weather market volatility.
During market swings you will want to speak with your Brown and Company financial advisor. They are best equipped to help you navigate the volatile market environment and take the emotion out of investing. Market volatility has an unfortunate way of knocking portfolios down and up in a short period of time. It is important to stick with your rebalancing strategy and speak with your financial advisor so you can discuss your short- and long-term goals and decide if an adjustment is needed.
Volatility should not in itself dictate your rebalancing frequency. You should refer to your plan and financial advisor for guidance. For example, if you hold several overperforming stocks or mutual funds that have risen quickly you may want to sell some to lock in gains. In turn, if the market falls you may want to buy some stocks to add to your portfolio. Whatever decision you make it should coincide with your rebalancing strategy.
You should avoid allowing your emotions dictate your portfolio rebalancing. Timing the market is impossible. Having a well-rounded predefined investment plan is the best outcome. This includes diversifying your assets and regularly rebalancing your portfolio.
How Life Events Can Change How Often You Should Rebalance
During your investing horizon you will find your goals may change. Certain life events such as marriage, divorce, birth of a child, and retirement will affect your rebalancing frequency and asset allocation. Whenever you have a major life event you should consider speaking with your Brown and Company financial advisor to discuss the next steps. This discussion may occur outside your regular meeting schedule. During this special meeting you can discuss how your life event will affect your portfolio rebalancing.
Each situation and person is unique. That is why meeting with your financial advisor to create a plan tailored to your specific needs is the best solution. Brown and Company provides detailed financial planning considerations that are tailored to your needs.
Special events, such as retirement, may require further discussion and portfolio projections. Brown and Company can provide insight into these special circumstances by helping you in balancing risk and income in retirement.
Tax Considerations When Rebalancing Frequently
As part of meeting with your Brown and Company financial advisor you should discuss the consequences of frequent rebalancing and how this may affect your specific tax situation. Brown and Company offers tax-aware investment planners to help you navigate tax questions.
Investors generally have either taxable accounts or tax-advantaged accounts. Each has a different purpose.
Taxable accounts are generally your standard brokerage accounts that offer stocks, bonds, mutual funds, exchange traded funds (ETFs), and other securities. You pay taxes on any dividends and capital gains realized during the year.
Tax-advantaged accounts offer tax-deferred growth potential or tax-free growth potential. These accounts are 401(k)s, individual retirement accounts (IRAs), Roth IRAs, health savings accounts (HSAs), and specific trusts. You pay taxes the taxes generally on withdrawal, or in the case of Roth IRAs, you use already taxed funds and pay no taxes on withdrawal.
Remember, frequent rebalancing leads to more taxes. Short-term gains held less than one year are generally taxed as ordinary income. Long-term gains held longer than one year are taxed at a lower rate depending on your personal tax situation. Holding onto your investments over the long term will result in greater portfolio gains and lower taxes.
If you are buying and selling frequently you can accumulate a significant tax bill. This will affect your portfolio performance over the long term. If you plan to buy and sell frequently you should do this in a tax-advantaged or tax-deferred account to minimize taxes generated.
Common Mistakes When Deciding How Often to Rebalance
Some common mistakes investors make are frequent rebalancing based on market volatility and ignoring your rebalancing strategy. Selling high performing assets too soon, selling in a down market due to fear, and ignoring the tax consequences and transaction or broker costs and fees, are all avoidable.
When investing you should stick to your rebalancing strategy you developed with your Brown and Company financial advisor. Reacting emotionally to market noise or world events is not a wise action. You should rebalance your portfolio based on a disciplined, agreed upon rebalancing strategy that will meet your investment goals. Remember to avoid the pit falls of over monitoring your portfolio, confusing rebalancing your portfolio with trying to time the market, and making portfolio changes without reviewing and adjusting your rebalancing strategy with your financial advisor.
How Often Should You Rebalance Based on Your Long-Term Plan
There is no “correct” rebalancing frequency. Each individual will defer depending on their specific financial situation, goals, and investment horizon. The regular rebalancing of your portfolio should be paired with a broader documented wealth strategy.
By partnering with your Brown and Company financial advisor you can develop a comprehensive investment plan that meets your unique needs and aligns with your investment goals, risk tolerance, and specific tax situation. We will craft a comprehensive strategy that that aims to favor long-term consistent returns over short-term gains. Please contact us to learn more.
The content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. -- This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.--- Investing involves risk including loss of principal. No strategy assures success or protects against loss. -- Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.--- There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.