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How to rebalance your investment portfolio in four simple steps

Financial Wellness

Having a long-term financial plan and sticking to it is an essential part of investment success.  However, a completely “set it and forget it” approach to investing is not safe.

It pays to revisit your portfolio at least once a year and check if your current asset mix is on target.  If it is off by 5%, you need to rebalance your portfolio.

Don’t panic.  Rebalancing is very easy to do and takes about 5 minutes. Let’s dive in.


Who should not worry about rebalancing?

You need to rebalance your portfolio unless:

  • All of your money is held in one target-date fund;
  • All of your money is invested with one of the Robo-advisors like Ellevest, Betterment, Wealthfront, etc. They will rebalance your portfolio for you;
  • You have a financial advisor who does the rebalancing for you.


If you don’t belong to any of the three abovementioned groups, listen up.  This article is for you.  Rebalancing is not complicated at all, so let’s get to it.


What is rebalancing, anyway?

An intelligent investment portfolio should be diversified among different asset classes.  In other words, you should spread your money among different buckets – stocks, bonds, real estate, and cash.

The mix of stocks, bonds, and other asset classes in which you invest your money is called asset allocation.  It is a personal decision, and there is no golden formula that works for everyone.

For example, with a 60/40 portfolio, you would put 60% of your money in stocks (or stock index funds), and 40% would go into bonds (or bond index funds).  60/40 is your asset allocation.

Over time, the prices of investments that you hold in your portfolio change.  Some go up, and some go down.  Therefore, the amount of money allocated to each asset class changes, and it becomes out of tune with your original asset allocation.

The process of bringing your portfolio to a target asset allocation is called rebalancing.  You would need to sell investments that outperformed and buy the ones that underperformed.  In other words, you would need to sell high and buy low – a golden rule of investing.

Why is rebalancing necessary?  Because it ensures that your portfolio will expose you to the right amount of risk so you can meet your long-term goals.


Four steps to rebalancing your investment portfolio

Step 1

First, you need to identify your target asset allocation mix. Let’s use the 60/40 portfolio as an example.  Assume you put $10,000 in the market – $6,000 into stock funds and $4,000 into bond funds.

Step 2

Second, decide how often you are going to rebalance and what other criteria might trigger the rebalancing.  Rebalancing at regular intervals (once a year, once a quarter, or monthly) is a great way to do it. It’s also a good idea to rebalance if your asset mix is off by 5% or more.

Step 3

Third, find out what your current asset allocation mix is.  Log into your brokerage account.  Most companies have that information on the main dashboard.  Here is a snapshot from my Fidelity account:

Let’s go back to our 60/40 example. Let’s assume that the stocks have done very well over the past year, and the value of your stock funds increased by 20% to $7,200 ($6,000*1.2).  Bond funds did poorly, and you lost 10% on them.  The value of your bond mix would be $3,600 ($4,000*0.9).

So, the total value of your portfolio a year later is $10,800 ($7,200+$3,600).  Your current asset allocation mix is as follows:  67% in stocks ($7,200/$10,800) and 33% in bonds ($3,600/$10,800).

Compared to your target asset mix of 60/40, you currently own too much in stocks and not enough bonds.  Stocks are inherently riskier than bonds, so your portfolio carries more risk now.

Step 4

Forth, you rebalance your portfolio by selling the asset class that you own too much of and buy the asset class that you own too little of—common sense.

In the example above, you should own $6,480 in stocks ($10,800 * 60% – current value of your total portfolio times your target stock allocation).  Instead, you have $7,200 in stocks.  Therefore, you sell $720 worth of equities ($7,200 – $6,480) and put that money into bonds.

Another way to rebalance is to direct new money into the “underweight” asset class.  For example, you deposited an additional $2,000 into your investment account.  So, right now, your asset mix looks like that:

Stocks:  $7,200

Bonds:  $3,600

Cash:  $2,000.

The total value of your portfolio is $12,800.  The target asset allocation would be $7,680 ($12,800*60%) for stocks and $5,120 ($12,800*40%) for bonds.  So, you would split your $2,000 cash position to buy $480 more of stocks ($7,680-$7,200) and $1,520 more of bonds ($5,120 – $3,600).

I’ve created a simple Excel spreadsheet to plug in your target mix and the current value of investments to see what you need to do to rebalance your portfolio.  You can download it here.

Keep an eye on taxes and fees

Rebalancing may trigger transaction fees, so be aware of that.  However, the effect should be negligible if you are not rebalancing your portfolio very often.

Also, selling securities in your taxable accounts will have tax implications.  To minimize the effect of taxes, try to use your tax-advantaged retirement accounts to do all the necessary buying and selling to bring your overall mix close to the target.

Finally, you can minimize capital gains taxes by using new cash contributions to buy assets that bring your allocation to target.


The bigger picture

Rebalancing is an integral part of long-term investing.  It gives you a chance to review your investments periodically and keep your portfolio’s risk level consistent.  Rebalancing should be done in light of your overall portfolio, not individual accounts.  Big picture.  Long-term perspective.  It only takes 5 minutes.

Download our spreadsheet “Rebalancing your investment portfolio” here. 

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