FILTERS
How Rebalancing Helps Keep Your Portfolio on Track

How Rebalancing Helps Keep Your Portfolio on Track

  • 04.22.19
  • Markets & Investing
  • Article

Revisiting your allocation helps keep your financial plan aligned with your goals, risk tolerance and time horizon.

When your portfolio is first constructed, it will ideally reflect your investment objective – a combination of your goals, risk tolerance and time horizon. Unless something changes, your portfolio should continue to align with those objectives. That’s where rebalancing plays a key role.

Rebalancing Basics

The investments in your portfolio generally grow at different rates. Typically, more volatile, or risky, asset classes come with higher returns, which means those asset classes may grow at a faster rate than less volatile asset classes. As those more volatile assets grow, they begin to take up a larger percentage of your portfolio than they originally did – meaning your portfolio’s overall risk may now be higher than you originally intended. Rebalancing is the practice of bringing your portfolio back to its original asset mix, or allocation, to restore the appropriate risk level.

There are various approaches to rebalancing, ranging from making no changes to setting very specific volatility-based limits around the different asset classes in your portfolio. Choosing a rebalancing approach calls for careful deliberation, and you should consider the impact it will have on maintaining your portfolio’s intended risk and return characteristics.

Different Approaches

Buy and hold is the simplest approach. Once your assets are invested, no changes are made and the assets are free to move with the markets. The assets with the highest returns (which are likely those with the highest risk) will grow the most, which can increase the risk of your overall portfolio.

With a time-based or constant mix approach, asset class proportions are brought back in line at regular intervals, such as monthly, quarterly or – mostly commonly – annually. Bear in mind that choosing to rebalance more frequently can mean more transaction costs, paying taxes on short-term capital gains and a potential loss of returns if an asset class is not given sufficient time to meaningfully appreciate.

A drift-based or contingent approach sets a threshold, also known as a tolerance band, around each of the asset classes in your portfolio and rebalances whenever a threshold is breached. Bands can be relative or absolute. For example, setting a 10% relative band around a 40% allocation would trigger a rebalance at 44% or 36%, while a 10% absolute band would allow the allocation to drift up to 50% or down to 30% before rebalancing.

Considerations for Your Rebalancing Strategy

In addition to costs associated with monitoring and trading, there are other factors you should consider when evaluating rebalancing approaches.

Asset class volatility: More volatile, or riskier, asset classes will breach tolerance bands in either direction much more often than less volatile asset classes. As a result, it may be more efficient to set a wider band around more volatile asset classes, unless you prefer the more frequent rebalancing.

Asset class weighting: With absolute bands, asset classes with small allocations must increase significantly to trigger a rebalancing event. Relative bands self-adjust based on the weighting of the asset, which many consider an efficiency advantage.

Other considerations: Tax implications, market conditions, and the objective of the portfolio are examples of important factors to consider when rebalancing.

Rebalancing your portfolio is key to helping maintain an appropriate level of risk. Talk with your advisor about the different approaches – he or she can help you determine which method best suits your unique financial plan.

There is no assurance any investment strategy will be successful. Past performance may not be indicative of future results.

Important Disclosures

Saling Wealth Advisors is an SEC registered investment adviser located in Louisville, Kentucky. Saling Wealth Advisors may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Saling Wealth Advisors’ web site is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Accordingly, the publication of Saling Wealth Advisors’ web site on the Internet should not be construed by any consumer and/or prospective client as Saling Wealth Advisors’ solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet. Any subsequent, direct communication by Saling Wealth Advisors with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Saling Wealth Advisors, please contact the state securities regulators for those states in which Saling Wealth Advisors maintains a registration filing. A copy of Saling Wealth Advisors’ current written disclosure statement discussing Saling Wealth Advisors’ business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Saling Wealth Advisors upon written request. Saling Wealth Advisors does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Saling Wealth Advisors’ web site or incorporated herein, and takes no responsibility therefor. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

This website and information are provided for guidance and information purposes only. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy. This website and information are not intended to provide investment, tax, or legal advice.