Broker Check

Portfolio Rebalancing

February 11, 2016

Any investment requires revision from time to time. Take your home for example; occasional upkeep is necessary to maintain the quality of the house you own. If you purchase a home, you can expect to eventually replace the roof, upgrade the HVAC systems, and remodel a room or bathroom. Your investment portfolio needs similar revisions in order to provide you the greatest possible return over the long haul. Portfolio rebalancing is an important aspect of investing, but what is it and what does it mean?

Examining Portfolio Rebalancing

Every investment portfolio has a target allocation for funds. When you initially establish your portfolio, your funds will be modestly balanced. However, over time your stocks and bonds will perform at varying levels, which can disrupt the balance of your portfolio. US News - Money notes that rebalancing your portfolio is the process of "adjusting your holdings - that is buying and selling certain stocks, funds, or other securities - to maintain an established asset allocation."

There are other reasons to rebalance your portfolio; such as, changes in your investment strategy or risk tolerance. The process of rebalancing alters the weight of each security or asset class in your holdings to fulfill new asset allocation goals. Most importantly, portfolio rebalancing is integral to the long-term success of your investing, and should be done in good or bad times.

Calendar Rebalancing

Regardless of how impressive your portfolio's performance has been in recent months or years, returning allocations to target weights on a period basis helps ensure stable performance and improved growth over time. This can be done quarterly or semiannually, and fortunately does not require constant monitoring. Checking on the balance of your portfolio periodically ensures that you can adjust based on shifts in the market that create imbalance.

Percentage of Portfolio

A reliable means of establishing a point at which you should consider rebalancing is to have a set percentage of portfolio that is acceptable for your assets. This acts as a threshold at which you can rebalance your portfolio. An example would be a 60/40 stock/bond portfolio with a 5% point rule. This simply means that the ideal allocation for your portfolio is 60% stocks and 40% bonds.

If your portfolio shifts slightly, within the established five point rule, that is admissible. For example, if it becomes 65% stocks and 35% bonds there is no need to rebalance. With that said, if either stocks or bonds stray outside that 5% margin though, it is time for a rebalance.

Managing Trade-offs

Portfolio rebalancing can come with transaction costs which are incurred every time you move assets between funds. It is vital that you first consider if the cost of those transaction fees is worth the benefit you will receive from rebalancing your portfolio at that specific point in time. In some cases, when all else is equal, you may be better off setting wider corridors for non-liquid assets such as real estate and private equity accounts because of the higher transaction fees often associated with those assets.

Taxable accounts should have more narrow corridors for rebalancing than tax-deferred accounts, and generally speaking you should consider setting more narrow corridors for higher volatility asset classes. You can also minimize the transaction cost of rebalancing your portfolio by using incoming cash deposits from 401(k) distributions or dividend payments from your portfolio.

In the end, portfolio rebalancing is important to long-term growth and success. CNBC cited a 2014 study that tracked portfolio performance dating from 1988 to 2014 and covering three-different types: rebalanced, no change, and changes based upon market performance alone. The results showed that the best performance came from the portfolio that was regularly rebalanced. For any help with your rebalancing process contact Manhattan Ridge Advisors.