Welcome to Day 13 of our 30-Day Easy Money Makeover! Every day in April, we're bringing you strategies to help you improve, and feel more confident about, your money situation. Follow along and see the rest of the calendar here.
Steering your portfolio is much like driving a car: Direction and alignment are key.
A tactic to help with that steering is rebalancing. That is, periodically buying or selling investments to maintain your chosen mix. The aim is to manage your risk while producing returns that keep you moving toward your goals.
“Many clients don’t even know what rebalancing is until we explain it to them,” says Mitch Tuchman, whose Palo Alto, California-based money-management firm is named (of course) Rebalance. “But it is a core part of how we manage money, and plays a key role in getting your retirement on track.”
It is totally natural for investments to become unbalanced as an outcome of moving markets. Let’s say you were aiming for a portfolio of 60% equities: After a prolonged market boom, you might find your mix at 70%, thanks to increased stock values.
If so, congratulations. But now might be a good time to look at rebalancing, to get closer to that 60% figure in your original plan.
Tweaking your investments now and then might seem like an annoying chore. But over time, it can reap big rewards in your retirement savings.
Money managers Vanguard Group recently looked at a hypothetical $100,000 portfolio over a 10-year period, from the beginning of 2005 to the end of 2014. It found that a rebalanced portfolio easily beat one that wasn’t rebalanced, by a full 5 percentage points—rising to $177,082 over that time frame.
Its crystal-clear conclusion: “Any reasonable rebalancing strategy beats not rebalancing at all.”
So how do you start getting your portfolio into balance? A few key pointers:
Rebalancing once a year should keep you on track. Every year—let’s say around New Year’s resolutions time—check out where your portfolio stands, and make the necessary adjustments. Do it twice a year, and you will stay even closer to your target allocations. But don’t go overboard and become obsessed, because “you can drive yourself crazy with this stuff,” laughs Tuchman.
Alternatively, you could take action when you hit a certain percentage. For instance, if the stock portion of your portfolio lands more than 20% off of its target weight, you might consider rebalancing, suggests Kevin Gahagan, a San Francisco financial planner with Private Ocean.
Of course, some investment vehicles handle all this stuff for you, such as robo-advisors, or target-date funds that automatically shift your allocations over time.
Your allocation targets will depend on factors like your age and risk tolerance. Baltimore-based money managers T. Rowe Price suggest these goals:
You can also drill down into more specific allocation targets. For example, within your equity basket, you may occasionally have to rebalance between your domestic and international holdings, depending on how those markets have fared. A helpful tool for DIY investors: Morningstar’s Portfolio X-Ray feature, which will tell you what your portfolio contains.
One consequence of rebalancing: Those investment transactions often come with fees and tax implications. If your brokerage is charging you $30 per trade, for instance, you need to take those costs into account. So whenever possible, do your rebalancing from within tax-advantaged accounts, which is free.
If you are working within taxable accounts, be smart about rebalancing, and try not to trigger too many taxable events. For example, if your accounts are a little heavy on stocks and light on bonds, try not to sell equities, which could trigger taxes come April 15. Instead, boost your bond percentage with a new lump-sum investment, or by deploying the dividends and interest that your portfolio has thrown off.
Or, if you have to extract some funds—as is mandated from retirement accounts after a certain age—“take withdrawals from those asset classes that have risen above their target weight,” says Gahagan.
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Rebalancing pushes investors to do the opposite of what comes naturally. Most of us like to ride our winners and get rid of our losers, for instance, when really we should be doing the reverse.
“Rebalancing forces you to buy when everybody is selling, and sell when everybody is buying,” says Tuchman. “Emotionally speaking, people really hate to do that. But that’s where you make money.”