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Over time, the investments in your portfolio can shift in value, and not always in the direction you planned.
Rebalancing is the process of adjusting your investment portfolio to make sure it still reflects the mix of assets you want. Learn more about this approach and when to apply it below.
Why rebalancing matters
Imagine you decided to split your money evenly between stocks and bonds for a 50-50 allocation. After a while, stocks performed well, and your allocation (due to the change in value) shifted to 60% stocks and 40% bonds.
This asset drift means the overall risk level of your portfolio has increased. By rebalancing, you bring your portfolio back in line with your risk tolerance.
This prevents exposure to unnecessary risk from having more aggressive investments than you’re comfortable with.
You’ll also avoid holding too much of a particular asset, which can make your portfolio more vulnerable to market swings.
When to rebalance
There are time-based and threshold-based methods you can consider to identify whether your portfolio is due for rebalancing:
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Based on a schedule
You can choose to rebalance on a fixed schedule, such as once a year or quarterly, no matter how the market is doing. This approach is often easier for beginners and passive investors.
You only need to set a reminder for a regular portfolio check instead of constantly monitoring your investments.
- Based on a threshold
This involves rebalancing when your allocation drifts past a specific point. For example, you may decide to act only when an allocation moves 5% off target.
Since this option requires a closer eye on the portfolio, it may be a better fit for those with an active strategy aiming to stay as consistent with their allocation as possible.
- Based on your situation
You’ll also need to rebalance if your target allocation shifts. This often happens because of a change in your financial situation or upon entering a new life stage.
For example, investors nearing retirement often downsize high-risk investments and move to safer assets since they’ll need to withdraw money sooner.
On the flip side, you may become more willing to take risks as your wealth increases.
Remember to keep transaction costs in mind when choosing a rebalancing approach. Fees can add up if you’ll frequently buy and sell investments.
How to rebalance
Rebalancing typically means selling some of your overweight assets and buying more of what has shrunk.
To minimize transaction costs, you can add new money to your portfolio. Putting fresh funds into underweight assets allows you to get back to your original plan without selling existing holdings.
