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4 Tips for Rebalancing Your Portfolio

4 Tips for Rebalancing Your Portfolio

| April 30, 2024

Just like following a roadmap to reach your intended destination while driving, a financial plan, which serves as a map of your investment goals and objectives, enables you to arrive at the retirement you want. 

If your vehicle gets out of alignment, it will take longer and cost more to get where you want to go. It could develop other problems or even break down. The same is true of your investments — if they get out of alignment with your core motivations, you could suffer losses and struggle to realize the retirement you have your sights set on. 

For this reason, it’s necessary to tune up your portfolio every so often to give yourself the best chance of achieving your investment goals. This occasional adjustment is known as rebalancing. Here are four tips for doing it successfully. 

What Is Rebalancing? 

Rebalancing your investment portfolio is about improving the diversity among your investments, including stocks, bonds, funds, real estate, and cash, to hedge against volatility and risk. 

When you set your investment strategy in motion, you allocate a preferred mix of assets based on your financial goals, timeline, and risk tolerance. Over time, your asset allocation will drift. For example, an investment portfolio that started with 60% stocks and 40% bonds might become 70% stocks and 30% bonds as the former outperform the latter. 

This shift in your portfolio, in which some investments grow and others shrink, is natural, even desirable. Having an investment portfolio that can withstand the ups and downs of the market through the short term and long term requires diversity. To achieve that, you must consider the following: 

  • Asset Classes: Including stocks, bonds, and cash 
  • Industries: Energy, technology, healthcare, etc. 
  • Company Size: Large-cap, mid-cap, small-cap, etc. 
  • Geography: Including both domestic and foreign companies 

Rebalancing your portfolio means resetting this diversification to your preferred asset allocation by buying and selling investments. 

Strategies for Rebalancing Your Portfolio 

Although the question gets asked repeatedly, there’s no ideal time to rebalance your investment portfolio. As important as it is to keep an eye on your investment, however, studies suggest there are limits to how often you should rebalance. 

You have the option to rebalance your investment portfolio based on time, a specified threshold, or both: 

  • Time: Set a schedule to rebalance your portfolio annually, semiannually, quarterly, or monthly 
  • Threshold: Rebalance your portfolio when your asset allocation drifts more than a preferred percentage (typically 5%) 
  • Time and Threshold: Combine both approaches to keep your overall risk in check 

The first step to rebalancing is looking at your asset allocation, which requires you to know your investments. But rebalancing frequently — say, daily or weekly — could be costly, lead to unexpected losses, or create tax issues from capital gains. 

4 Tips for Rebalancing Your Investment Portfolio 

Consider these four tips when rebalancing to improve the performance of your investments without affecting your risk-return profile. 

  1. Focus on Your Retirement Accounts

If you rebalance taxable investment accounts, you may end up paying capital gains taxes. However, you can rebalance tax-advantaged accounts, such as your 401(k), individual retirement account (IRA), and Roth IRA, to avoid capital gains. 

  1. Invest or Withdraw Funds

Put your investment portfolio back in balance by identifying underweighted and overweighted assets. Then, invest funds — whether from regularly scheduled contributions, dividends, or interest — in the underweighted assets and withdraw funds from the overweighted assets. 

  1. Avoid the Temptation to Time the Market

Remember, the idea is to realign your investment portfolio with your long-term goals, wishes, and preferences. As such, you’ll need to avoid the temptation to try to maximize profits by following a conventional course like buying low and selling high. 

  1. Think About Related Costs

You’re rebalancing to find an equilibrium between risk and reward, but there are costs to consider, namely transaction fees and taxes. 

If you want to manage these costs, it may not be necessary to fully rebalance your portfolio. Alternatively, you can focus on asset classes that are extremely underweighted or overweighted to limit fees and taxes. 

There’s no need to completely overhaul your investment portfolio. It’s enough to restore a balance of diversity that manages risks and allows your investments to continue growing. 

Consult a Financial Advisor for Assistance 

You might feel like you have a good enough grasp on your investment strategy to go it alone. However, a financial advisor from Good Life Morehead City can make it much easier to choose a winning investment strategy and keep an eye on your portfolio. 

If you’re looking for advice on rebalancing your portfolio, get in touch with Good Life Morehead City today to schedule a consultation.