The Importance of Rebalancing
By: Cameron Diehl, CFP®
Friends – I hope this finds you all well and enjoying your summers as best you can in our new normal. Over the past few weeks I’ve spent the majority of my time at work meeting virtually with new and existing clients, catching up, checking in on financial plans and reviewing portfolios.
Throughout these conversations, one of our most important steps is regularly rebalancing portfolios. At the highest level, this is the idea of returning a portfolio to its intended mix of investments (i.e. stocks vs. bonds) after it may have drifted a bit. For example, if you have a target of 60% stocks and 40% bonds, overtime if stocks perform well, this might shift to something like 65% stocks and 35% bonds. Disciplined rebalancing would call for returning your portfolio to your targets by either selling stocks, buying bonds or a combination of both.
Rebalancing is primarily about managing risk and avoiding overconcentration in any one area. It can also help increase returns and even offer tax benefits if done strategically. The benefits can be so significant that one of my favorite financial authors, Nick Murray, writes that rebalancing is “as close as we ever get to a free lunch in portfolio management.”
With that in mind, I wanted to share a few thoughts on rebalancing and how you might think about it within your planning and investing.
- Get Clarity & Have A Plan – Before you can start rebalancing, you have to know both your targets and current investment allocation. How to do this is beyond the scope of this post, but if you’re not sure how to get started, I can help.
- Rebalance Within Asset Classes – Beyond the highest level of stocks vs. bonds, it’s important to rebalance further within those asset classes. Just considering stocks, you can look at large vs. small company stocks, value vs. growth stocks, U.S. vs. international stocks and the list goes on.
- Buy Low, Sell High – One of my favorite aspects of rebalancing is that it essentially forces you to buy low and sell high. Even when stocks are at highs, not everything will be peaking at the same time. This can help you find opportunities regardless of market conditions.
- Avoid Unnecessary Taxes – When you’re deciding what to sell and within which accounts, it’s important to be aware of the tax implications. Being mindful of capital gains taxes (especially short term) is important, either by selling within tax-advantaged accounts like IRAs or 401(k)s or strategically selecting investments with the smallest gains and long enough holding periods.
- Use New Money – An even easier way to rebalance without having to sell investments can be through ongoing contributions to your accounts. By thoughtfully allocating new money coming in, you can essentially rebalance with every new purchase and avoid any adverse tax consequences.
- Take Extra Care During Retirement – As you get into retirement, rebalancing becomes even more important as a way to begin efficiently making withdrawals to generate income or satisfy required minimum distributions (RMDs).
- Give Thoughtfully – I’ve written previously about tax-efficient giving. Using these strategies in conjunction with rebalancing your portfolio can be even more powerful.
- Maintain Discipline – When rebalancing, I recommend picking a specific date each year or a level of how far off track you’ll allow your portfolio to get before rebalancing and sticking to those triggers with discipline and no emotion. Anything else is market timing. No matter what approach you take to keeping your portfolio on track, the most important thing is steady consistency over many years.
- Capitalize on Volatility – When markets experience extreme volatility like we saw earlier this year and quickly throw your investments off track, rebalancing opportunistically can be one of the best ways to profit from a downturn. This can be extremely difficult in the moment and feel counterintuitive and scary but has often paid off in the long run.
- Rebalance Your Entire Balance Sheet – Beyond just stocks and bonds, another level in financial planning is looking at the balance across your entire net worth. This includes cash, stocks, bonds, private investments, business ownership, real estate and any debt you may have. Looking at your complete financial picture in this way can provide some of the most significant opportunities to strategically grow your wealth over time.
If you have any questions about your portfolio or how to make sure it’s well positioned to help you reach your goals, please don’t hesitate to reach out. I’m always happy to help
Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability. Past performance may not be indicative of future results. You should discuss any tax or legal matters with the appropriate professional.
