Rebalancing Your Portfolio

  • Rebalancing Definition: Rebalancing your portfolio entails selling assets that have appreciated and buying assets that have decreased in value to maintain your desired asset allocation.
  • Simple Rebalancing Example:
    • Investor A has a desired asset allocation of 75 percent stocks in an S&P 500 ETF and 25 percent bonds in a total bond market ETF.  For the sake of easy analysis, let’s assume Investor A’s stocks are valued at 7500 and his bonds are value at 2500 (10,000 total).
    • The stock market over the course of several months falls by 20 percent, decreasing the value of his/her S&P 500 ETF shares to $6000 ($7500 minus 20%, or $1500).  In the meantime, the total bond ETF increases by 5%, or $125, to $2625 total, as investors flock to bonds amid the stock market turmoil.  After the correction, his portfolio is now 69.57% stocks ($6000/$8625) and 30.43% bonds ($2625/$8625).
    • Investor A’s percentage of stocks has decreased over 5% because of the dip in the stock market, while his/her bond portfolio has increased over 5%.  Because of the major change, Investor A may want to rebalance the portfolio to maintain the 75/25 stock to bond allocation by buying more stocks and selling bonds.
    • Since the new portfolio is now valued at $8500, Investor A’s stock allocation would need to increase to $6375, meaning he/she should purchase $468.75 worth of equities and sell an equivalent amount of bonds.  His/her new portfolio after the major change and the rebalancing would show $6468.75 in stocks and $2156.25 in bonds.
  • Benefits of Rebalancing: Rebalancing helps people maintain the disciple to “buy low and sell high”, and avoid the human urge to buy assets that have had recent success and sell those that have depreciated.  Using the above simple example, you’ll notice that Investor A ultimately purchased $468.75 worth of equities at a 20 % lower price, and sold his bonds at a 5% higher price.
  • Regular Schedule vs. Percentage Threshold: One benefit of rebalancing on a set schedule is that you can set a recurring calendar event for your rebalancing and leave your portfolio alone until the date.  This approach requires less time and attention and is more predictable.  The downside of rebalancing only on a regular schedule is that a major swing in the market could occur in between scheduled rebalances, leaving several months to pass before being able to rebalance.
  • Tips:
    • Keep in mind that when and how you rebalance will likely differ between taxable and non-taxable accounts.  Selling assets in a taxable brokerage account could trigger a taxable event.  You should consult a tax professional when considering the tax implications of your decisions.
    • If you have enough available funds to contribute to your account, you can rebalance your portfolio without selling any assets.  This would be even more important in a taxable account, as it could help you avoid selling assets that would trigger a taxable event.  This is also beneficial if you expect the assets  with recent success to continue appreciating, in which case you can hold them without selling and still rebalance by purchasing the other assets that has decreased.