When to Rebalance Your Portfolio

Rebalancing is the process of realigning a portfolio’s weighting among the different asset classes. Rebalancing typically involves buying or selling securities to remain within the boundaries of a stated asset allocation strategy. This article will discuss when it is appropriate to rebalance.

Investors should consider rebalancing their portfolios when one of two events occurs: first, an investor should think about rebalancing according to a certain amount of time. For example, it is wise to at least review a portfolio once each year. An annual overview allows an investor a regular, periodic review of their asset allocation to determine whether the portfolio remains properly structured.

Alternatively, investors should consider rebalancing if their asset allocation becomes out of sync with their investing policy statement. For instance, assume an investor has structured a portfolio of 60% equity and 40% fixed income and strictly wants to remain within that framework. If, during the course of the year, the equity markets perform extremely well, and the fixed income component performs poorly, this investor will likely see the equity allocation rise above 60% as a percentage of the overall portfolio.

This would compel an investor to rebalance in order to stay within the predetermined asset allocation. If, using the same example, the strong performance of the stock market lifted the equity allocation to 70%, an investor should think about selling some equities and/or purchasing additional fixed income investments to bring the portfolio back to the desired 60/40 split.

Strategic asset allocation describes a portfolio management model in which an investor sets a strategy for allocating assets among different asset classes, then rebalances the portfolio periodically (for example, each year) to remain within the targeted strategy. Meanwhile, tactical asset allocation allows for a range of allocation within a portfolio. For example, a tactical asset allocation strategy could allow for 40%-60% equity exposure, and the investor can rebalance to remain within that range.

Investors can turn to exchange traded funds, otherwise known as ETFs, for model portfolios. There are many ETFs that automatically construct portfolios with various asset allocations, depending on an investor’s individual investment goals and risk preferences. There are ETFs that provide total portfolio asset allocation, ranging from more aggressive to more conservative, or somewhere in between.

A more aggressive asset allocation ETF would include the iShares Core Aggressive ETF (AOA A-). This fund is comprised of 79% equity, 19% fixed income, and the remainder in cash and commodities. Among its fixed income holdings, 62% are rated triple-A. On the other hand, a more conservative approach could be the iShares Core Moderate Allocation ETF (AOM A). This takes basically the opposite approach as the aggressive fund: the AOM fund is comprised of 40% equity and 59% fixed income, with the remainder in cash.

For an idea of a great asset allocation, check out the Low Risk All Weather Portfolio.

Rebalancing is an important aspect of portfolio management. The investor should reevaluate their portfolios every six months, or at least once per year, to make sure the asset allocation remains aligned with their personal investment policy statement and risk tolerances. When equity markets or fixed income markets perform relatively well or poorly, it can skew a portfolio too heavily toward one or the other. As a result, investors should rebalance their portfolios as necessary.