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Monitoring your risk level & rebalancing

Remember that asset mix you chose? Check your investments against it and rebalance when needed so you don't drift off course.

POINTS TO KNOW

  • The risk level of your portfolio can change over time.
  • If it gets too far off your original plan, you'll need to bring it back into balance.
  • Your target asset mix may also need to change over time.

Don't lose your balance

It might seem surprising that your portfolio's risk level could change even if you didn't change any of your investments. But when one asset class is doing better than the others, your portfolio could become "overweighted" in that asset class.

For example, imagine you selected an asset allocation of 50% stocks and 50% bonds. If 4 years go by during which stocks return an average of 8% a year and bonds 2%, you'll find that your new asset mix is more like 56% stocks and 44% bonds.

Two pie charts showing a portfolio becoming unbalanced due to market returns.
Two pie charts showing a portfolio becoming unbalanced due to market returns.

Check your portfolio at least once a year, and if your mix is off by at least 5 percentage points, consider rebalancing. There are a couple ways you can do this.

Buy more of one kind of asset

In the example above, you have too much in stocks and not enough in bonds. So you could direct additional money to your bond investments to bring your portfolio back in balance. (The money could come from new investments or from distributions.)

Move money from one type of asset to another

You could also move some money from your stock portfolio into your bond portfolio. This will immediately realign you with your target.

Note that if you invest in a taxable account, selling investments that have gained value will most likely mean you'll owe taxes. To avoid this, you could rebalance only within your tax-advantaged accounts. You can ask a tax advisor if you have questions about your own situation.

The danger of not rebalancing

It can be hard to convince yourself to rebalance. Selling "winning" shares probably goes against your instincts. But it reflects one of the simplest distillations of investing wisdom: "Buy low, sell high."

If you don't rebalance, you'll wind up with an asset mix that doesn't match your risk tolerance.

Having a larger-than-planned allocation to stocks may seem harmless when stock prices are up. But no market rally lasts forever, and when the tide turns, you'll be overexposed to the drop. As the chart below shows, someone who never rebalanced would likely see his or her portfolio's risk level (as measured by allocation to stocks) increase consistently over time.

Rebalance to keep control of your portfolio's risk

A graphic showing that a portfolio that's never rebalanced over 30 years will become increasingly risky compared with one that is rebalanced

Source: Vanguard Capital Markets Model® (VCMM). The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM is derived from 10,000 simulations for each modeled asset class. Simulations as of December 31, 2014. Results from the model may vary with each use and over time. For more information about VCMM, see below.

For both charts, the simulation represented is the VCMM simulation with the median return after 30 years. In one scenario, the portfolio is rebalanced at the end of each year; in the other scenario, it is never rebalanced. Stocks are represented by the MSCI AC World IMI Index. Bonds are represented by the Barclays Global Aggregate Bond Index (USD hedged). Portfolios are initially weighted 50% stocks/50% bonds.

Go in-depth

Read our white paper explaining "how often, how far, and how much" a portfolio should be rebalanced.

Life changes—so should your risk level

There are a lot of reasons you might need to rethink the amount of risk you're taking.

If something significant has changed with your overall goal or with your life circumstances, you should check your asset mix and see if it still works for you.

For example, your timeline is always growing shorter. An asset mix that worked for a goal that was originally 20 years away might not be appropriate when your goal is now only 5 years away.

The amount you're shooting for may change too, if you find out you need less or more than expected.

Or you could discover that your risk tolerance isn't as high as you thought it was. Seeing your balance drop significantly might not be too scary in theory—but the reality often is harder to take. If you find that you can't stomach the ups and downs, it's time to change your plan.


WATCH AND LEARN

Having trouble rebalancing? It can be difficult to sell assets that are doing well in order to buy those that seem to be struggling. But think about the next 30 years, not the next 12 months.


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REFERENCE CONTENT

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Portfolio

The sum total of your investments managed toward a specific goal.

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Risk

Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.

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Asset class

A major type of asset—stocks, bonds, and short-term or "cash" investments.

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Asset allocation

The way your account is divided among different asset classes, including stock, bond, and short-term or "cash" investments. Also known as "asset mix."

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Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

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Rebalance

To move money in your account so that your overall portfolio aligns with the asset mix you selected, usually after market movements have caused it to change.

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Market

The trading of a universe of investments, based on factors like supply and demand. For example, the "stock market" refers to the trading of stocks.

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Rebalance to keep control of your portfolio's risk

This graphic shows the difference between a portfolio that is rebalanced annually and one that is never rebalanced, over a 30-year period. The rebalanced portfolio begins with a 50/50 stock/bond allocation, and the allocation remains relatively close to the 50/50 split throughout the 30 years. The nonrebalanced portfolio begins with the same allocation, but the portfolio steadily increases its allocation to stocks over time, resulting in more risk.

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Don't try to time rebalancing

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Don't try to time rebalancing

Colin Kelton: Let's talk a little bit more about portfolio construction and diversification, and Mark from Melbourne Beach asks, "What are the best signals or triggers to use in determining when to rebalance?" So, again, we're talking about a total-return approach. Your portfolio, based on market conditions, is not going to be tomorrow what it was today. Catherine, how would you answer that question?

Catherine Gordon: I think there are actually two "triggers," as reluctant as I may be to use that word. I think the first is, adopting a rebalancing policy to—if you have a target asset allocation, whatever that is—build some ±1%, ±2%. We generally look at ±5% points. This is a perfect time, particularly given where the equity market has been over the past couple of years. People may have a target allocation of 60% in stocks, 40% in bonds, but maybe that portfolio has crept up to 67% or 68%. You know, looking at rebalancing to that target, just given market conditions. And, you know, the earlier question about, "Gee, should I keep buying stocks or keep buying bonds given the outlook?" That's the discipline of rebalancing.

So the first trigger would be, "Where am I relative to my target asset allocation?" The second trigger would be, I think, extremely personal. So I am now five years closer to retirement than when I first set up this asset allocation. My kid is now in high school. You know, I set up this initial allocation. We did it when he or she was eight. So as people start thinking about getting closer to the actual goal, that's a really good trigger for, "Do I have the right asset allocation given that my time horizon is now five years and not ten?"

Colin Kelton: Here's a good follow-up question to that on rebalancing, and Wallace from Livermore, California, asks, "So rebalancing now would just cause me to buy more bond funds, and it doesn't seem like a great time to be buying these." So how is somebody like Wallace to think through that question? "I don't want to give up these stocks. They've done well. Boy, I'm going to buy bonds. Um, I'm not so sure about that right now."

Chuck Riley: I think that one of the things to consider, so, yeah, so bonds are at elevated levels because of the low interest rates. But if you are allowing your portfolio to continue to climb in stocks—if you're going from 60% to 65% or at 70%, 75% in the stocks, or what have you—you're actually taking on a lot more risk with the stocks because of that volatility.

And so, rebalancing is a key part of the total-return approach because if you need extra spending money beyond the income of your portfolio, then rebalancing is the way to generate that cash. So if your stocks are elevated and you need spending money, you know, so when you sell the stocks in your portfolio, that's how you come up with that cash. So maybe you're not buying more bond funds. Maybe you're actually using that cash to fund whatever spending that you have, and you're just getting back to the target.

But, when folks say to me, "Is this a good time to buy stocks? Is this a good time to buy bonds?"—again, to Catherine's point, looking out at the time horizon—I'm like, "I hope that this is not an all-time high for the stock market. I've got a long way to go, so I'm really hoping that this is a low for 20, 30 years." And that's how investors really should approach it, rather than thinking about, "Well, what's it going to do in the next year?"


All investing is subject to risk, including the possible loss of the money you invest.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

We recommend that you consult a tax or financial advisor about your individual situation.

This webcast is for educational purposes only.

Diversification does not ensure a profit or protect against a loss.

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