Portfolio Rebalancing: Part of the Financial Planning Process

By : Teresa Conley | January 28, 2018

In regards to rebalancing investment portfolios, the three most common questions our wealth advisors hear are: “How often should rebalancing be done?”, “How important is it?”, and “What happens if it’s put off to a later date?”

While portfolio rebalancing isn’t one of those tasks anyone necessarily looks forward to with any amount of enthusiasm – in fact, for many investors (and investment professionals) it’s about on the same level as cleaning leaves out of the roof gutters or organizing your file cabinet – it’s also a key element in maintaining diversification and a portfolio that balances growth and return.  More importantly, rebalancing manages risk in your portfolio.

Here are the top reasons why investment portfolio rebalancing should be on your to-do list of wealth management strategies. 

Strategic Wealth Planning: How Does Imbalance Occur?

If you’ve received good investment guidance, you’ve already got an adequately diversified portfolio. And, if you’ve chosen asset classes properly, they won’t grow at the same rate each year.

For instance, say your portfolio allocation is similar to that of this example of a diversified portfolio:

U.S. Large Growth 20 percent
U.S. Large Value 20 percent
U.S. Small Growth 20 percent
U.S. Small Value 20 percent
International Large Companies 10 percent
International Small Companies 10 percent
TOTAL 100 percent

Now imagine that in the first year, U.S. Large Growth stocks have a 15% rate of return (ROR) and U.S. Small Value stocks have a -10% ROR. By the end of the year, your allocations will have shifted from where they started; U.S Large Growth will be over-weighted and U.S. Small Value would be under-weighted.

Wealth Management Strategies and Rebalancing

When dealing with an unbalanced portfolio, you have two options:

  1. Leave the (changed) allocations alone
  2. Re-establish the original percentage allocations through rebalancing

If you choose door number two, the rebalancing process — or getting back to your original allocation plan – would involve selling some U.S. Large Growth and purchasing more U.S. Small Value. While selling winners and buying losers seems counterintuitive to you, you’re not alone – this wealth management strategy takes some discipline. Think of it as buying low and selling high, if that helps.

However against the grain it may seem, portfolio rebalancing keeps your portfolio diversified. If you procrastinate, your portfolio will grow overly concentrated in the asset class that happens to have the best recent performance. Unless your original allocation wasn’t logical, you’ve gained new information, or something has happened to change your rationale, your best course of action is to maintain your initial allocation through rebalancing.  

And what happens if you don’t rebalance?  The shifts in your allocations may dramatically increase your risk. 

Portfolio Rebalancing: A Regular Part of the Financial Planning Process

Portfolio Rebalancing

Tax considerations influence how often you should rebalance, whether annually, quarterly, when your portfolio changes by a certain percentage, or less often. For instance, if your funds are in a retirement account, you can rebalance without incurring a tax burden. But if your account is taxable, rebalancing might result in taxable income. In that case, you may want to rebalance less often. In that case, seek guidance from your wealth advisor and tax adviser.

Unequal performance across asset classes is to be expected. After all, it’s happened in the past – isn’t that a big part of the reason why you selected those particular classes in the first place? – Provided that it happened in the past, it’ll likely happen in the future as well. Unless something truly unexpected has happened, why alter your plan? Maintaining discipline when it comes to investing is key to investment success.

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