3 rebalancing tips to fine-tune your portfolio
Life’s full of big decisions―choosing a home, buying a car, selecting financial accounts that will meet your needs and help build a secure future for you and your family.
These big-ticket purchases require routine care and attention to help you get the most from them. A regular spring cleaning like power washing your home’s exterior, checking your car’s oil, and rebalancing your financial portfolio can go a long way in protecting your investments.
Check your portfolio regularly
You built your portfolio’s target mix based on your goals, time horizon, and risk tolerance. But goals can change and market fluctuations can cause your asset allocation to shift, so it’s important to monitor your portfolio on a regular basis and make adjustments as needed.
Did you know your portfolio’s risk level can change even if you didn’t alter any of your investments? Here’s how it works. Over time, your allocation will begin to drift away from your target mix in favor of better-performing, often riskier, assets. As a result, you may find that you’re overweighted in stocks, for example―exposing you to more risk than you’re comfortable with.
Let’s say you have a portfolio of 70% stocks and 30% bonds and you’ve decided to rebalance when your allocation is off target by 5 percentage points or more. During your annual review, you notice your portfolio’s drifted to 76% stocks and 24% bonds. It’s now time to make some adjustments to stay on track with your risk and return objectives. You can either rebalance your portfolio back to the 70/30 mix or set a new target if your goals or circumstances have changed and caused you to become more or less conservative.
- Maintain focus on your long-term goals. Making short-term changes to your portfolio in response to volatile markets generally has a small impact on your ability to achieve your goals.
- Limit how often you rebalance. Rebalancing too frequently can come at the cost of lower returns and a heavier tax burden.
- Use one of these rebalancing strategies:
- Time: Rebalance your portfolio on a predetermined schedule such as quarterly, semiannually, or annually (not daily or weekly).
- Threshold: Rebalance your portfolio only when its asset allocation has drifted from its target by a predetermined percentage.
- Time and threshold: Blend both strategies to further balance your risk.
Not sure when to rebalance your portfolio?
We recommend checking your asset allocation every 6 months and making adjustments if it’s shifted 5 percentage points or more from its target.
However, if this doesn’t work with your schedule, don’t stress about the specifics. There isn’t one rebalancing strategy that’s consistently outperformed another, according to our research.* The important thing is to pick a schedule that’s easy to follow, set a reminder on your calendar, and stick with it.
Minimize transaction fees and taxes
When it’s time to rebalance your portfolio, consider these tax-efficient best practices to potentially further improve your investment performance without sacrificing your risk/return profile.
Focus on tax-advantaged accounts
Selling investments from a taxable account that’s gained value will most likely mean you’ll owe taxes on the realized gains. To avoid this, you could rebalance within your tax-advantaged accounts only.
Rebalance with portfolio cash flows
Direct cash inflows such as dividends and interest into your portfolio’s underweighted asset classes. And when withdrawing from your portfolio, start with your overweighted asset classes.
Consideration: If you’re age 72 or over, take your required minimum distribution (RMD) from your retirement account(s) while you’re rebalancing your portfolio. You can then reinvest your RMDs in one of your taxable accounts that has an underweighted asset class.
Be mindful of costs
To minimize transaction costs and taxes, you could opt to partially rebalance your portfolio to its target asset allocation. Focusing primarily on shares with a higher cost basis (in taxable accounts) or on asset classes that are extremely overweighted or underweighted will limit both taxes and transaction costs associated with rebalancing.
Manage risk and emotion
Every investor’s dream is to buy low and sell high. But the purpose of rebalancing is to manage risk, not maximize returns. Rebalancing isn’t about market-timing; it’s about sticking to Vanguard’s principles for investing success and creating a strategy to stay in sync with your long-term goals.
So what does this mean for you?
Since bull and bear markets don’t last forever, it’s important to remove yourself from difficult decisions by sticking to a fixed rebalancing strategy. It’s a great way to take your emotions out of investing, keep your allocation in check, and limit the higher taxes associated with frequent rebalancing.
Ready to put a rebalancing strategy into action?
Find a variety of do-it-yourself resources to help boost your rebalancing knowledge and determine a plan that works for you.
Don’t have the time to monitor and rebalance your investments? Check out how our advice services can make your life easier.
*Vanguard, Getting Back on Track: A Guide to Smart Rebalancing (Jenna L. McNamee, Thomas Paradise, and Maria A. Bruno, CFP®, 2019).
All investing is subject to risk, including the possible loss of the money you invest.
We recommend that you consult a tax or financial advisor about your individual situation.
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