How to Rebalance Your Portfolio for Better Returns

Investing isn’t a “set it and forget it” game. Market fluctuations constantly shift the proportions of your investments, and without action, your portfolio can drift away from your initial risk tolerance and desired returns. This is where portfolio rebalancing comes in.

What is Portfolio Rebalancing?

Rebalancing is the process of bringing your investment portfolio back to its original asset allocation. It's essentially a way to proactively manage risk and maintain your strategy. Over time, some investments will outperform others, causing your portfolio to drift. For example, if stocks have a particularly strong year, your equity allocation will increase, while bonds might lag behind.

Why is Rebalancing Important?

Risk Management: Drifting asset allocations increase your overall risk. By rebalancing, you ensure you're not taking on more risk than you’re comfortable with.
Improved Returns: While it might seem counterintuitive, rebalancing can actually improve returns over the long term. Studies show that investors who rebalance regularly tend to outperform those who don't. This is because rebalancing forces you to sell high and buy low, capitalizing on market inefficiencies.
Disciplined Approach: Rebalancing helps you stick to your long-term investment strategy, preventing emotional decisions driven by market volatility.

Key Strategies for Rebalancing

Determine Your Target Asset Allocation: This is the cornerstone of your rebalancing strategy. Based on your risk tolerance, investment goals, and time horizon, decide what percentage of your portfolio should be allocated to stocks, bonds, real estate, and other asset classes. A common starting point for a long-term investor might be 60% stocks and 40% bonds, but this is just an example – tailor it to your situation.
Choose a Rebalancing Frequency: There's no one-size-fits-all answer. Common frequencies include:
- Calendar-Based: Rebalance annually or quarterly. This is simpler but may result in higher transaction costs.
- Threshold-Based: Rebalance when an asset class deviates from its target allocation by a certain percentage (e.g., 5% or 10%). This is more dynamic and responsive to market changes.
Methods for Rebalancing:
- Selling High, Buying Low: This is the most fundamental approach. Sell the overperforming asset class and use the proceeds to buy the underperforming asset class.
- Dollar-Cost Averaging (DCA): If selling large portions of your portfolio could trigger significant price drops, consider DCA. Sell a fixed amount regularly, regardless of the asset’s price.
Consider Transaction Costs: Rebalancing involves trading, which can incur brokerage fees and potentially capital gains taxes. Factor these costs into your strategy. Low-cost index funds and ETFs can help minimize these expenses.

Tools and Resources:

Portfolio Tracking Software: Utilize software like Personal Capital, Mint, or Quicken to track your portfolio’s performance and automatically generate rebalancing recommendations.
Index Funds & ETFs: Low-cost index funds and ETFs provide efficient exposure to various asset classes, simplifying the rebalancing process.

Disclaimer: This blog post is for informational purposes only. Consult with a qualified financial advisor before making any investment decisions.*