It’s Critical to Ensure Your Portfolio Remains Aligned with Your Investment Goals and Risk Tolerance
Will you be rebalancing your portfolio this year? If your answer is no, it’s time for a wake-up call.
One of the common mistakes we see among potential clients when they walk through our door for the first time is that they’ve become complacent with their portfolios. Maybe at one point, they had a thoughtful strategy. Maybe their assets were perfectly balanced according to their needs and goals. Maybe they had positioned themselves quite well. But then what happened? Time went on, they became complacent – or maybe just busy – and suddenly they have portfolios that don’t properly balance risk and reward or truly serve their goals anymore.
Look, the market changes all the time, and that means your perfect, thoughtful portfolio can get thrown out of whack pretty frequently. That’s why it’s a mistake to “set it and forget it” and just hope you’ll still receive the returns you want. Rebalancing is essential, and we’re digging into the details for you in this article.
What Exactly is Portfolio Rebalancing?
Rebalancing is the practice of periodically reviewing your investment portfolio to make sure you’re striking the right balance between securities, like stocks, stock ETFs, stock mutual funds, and more conservative investments, such as bonds/cash. The point is to ensure your portfolio is never weighted too far in one direction and that it’s always aligned with your personal risk tolerance and risk capacity.
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Here’s an example to illustrate:
Let’s assume you like to keep a moderate portfolio with a balance of 50% stocks and 50% bonds. You invest $10,000 evenly between these two macro asset classes and then you don’t make any changes for five years. At that point, you realize your stocks have doubled in value, making them worth $10,000. Your bonds have grown 20% in value, making them worth $6,000.
So, you have a portfolio that’s now worth $16,000 – and you’re probably pretty happy with how your assets have grown, particularly your stocks. The trouble is, you still feel most comfortable with a moderate stock-to-bond asset allocation strategy of 50% stocks and 50% bonds, but your stocks now make up nearly 63% of your total investments. Essentially, higher-risk assets now make up a heavier proportion of your total investment portfolio than what you intend. You’re more reliant on stocks than you want to be.
Enter: Rebalancing.
When to Rebalance
A common question we get is whether there’s a preferred schedule for rebalancing your portfolio, especially since the market changes every day and the values of your various asset classes change every day, as well. Rebalancing is definitely not something you need to be doing every day. You’ll get lost in the minutiae of all the small ups and downs and lose sight of the bigger picture. However, you don’t want to wait five years, like in the above example, either.
The important thing is to be consistent, so set a schedule to rebalance at a regular interval that feels right for you. It might be monthly, quarterly, or annually. This allows you to stay up to speed with any meaningful, big-picture changes happening in your portfolio. It’s also a good opportunity to review gains and losses and choose whether to redirect your investments elsewhere if they’re not performing for you.
If you’re not accustomed to rebalancing and you aren’t sure you can sustain a schedule, commit to at least rebalancing every time your asset allocation changes significantly. For instance, maybe a 10% shift in either direction is your limit before you take the time to rebalance that shift in weight. The only tricky thing here is that you don’t want to react too quickly to instances of short-term volatility.
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Other Rebalancing Considerations
Since rebalancing is all about staying aligned with your desired asset allocation, it’s important to remember that’s something that will shift over time. As your time horizon changes, your risk tolerance and risk capacity are bound to fluctuate. So, be sure you don’t rebalance according to previous goals that no longer apply. Each time you reassess your asset allocation, it should be within the context of your current phase in life and the risk tolerance and risk capacity that goes along with it.
The passage of time won’t be the only thing that impacts your risk tolerance either. It can fluctuate based on any number of other factors, including your income level and investment goals. Your personal life matters, as well. Life transitions like marriage and children often necessitate a new approach to how much risk you can handle.
Final Thoughts on the Importance of Rebalancing Your Portfolio
Keeping a schedule and rebalancing periodically is the best way to align your risk appetite with your exposure. You have to coordinate your asset allocation with your investment goals – and not for just one moment in time. Having a “set it and forget it” mentality to your investments won’t help you achieve your long-term goals. Instead, put a system in place where you revisit your asset allocation at planned intervals or anytime there are significant shifts in your portfolio.
If you currently work with a traditional stockbroker or another type of financial professional don’t assume they are rebalancing your portfolio on a regular basis. Over our 30 plus year history of providing portfolio reviews and analysis to prospective clients, we typically see large embedded unrealized capital gains in portfolios which are an obvious sign your financial advisor is not actively rebalancing your portfolio. Large embedded unrealized capital gains can also disappear quickly during market corrections. Always remember you will never go broke taking a profit and portfolio rebalancing is one of the best ways to achieve this goal.
If rebalancing on your own seems overwhelming, partner with a professional Registered Investment Advisor (RIA). At Davidson Capital Management, we can take the stress out of rebalancing by actively managing your portfolio through our disciplined and transparent approach. Contact us today to schedule a call and to learn more about our investment management services.
