Portfolio Rebalancing: How Much Is Too Much?

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Rebalancing is a good way to keep your portfolio “pie” well diversified and risk levels under control.

Portfolio rebalancing has been in every investor’s tool kit for decades.

When you rebalance, you cut back on portfolio sectors that have gotten too big, and add to portfolio sectors that have fallen below their target levels.

This helps keep your overall stock/bond allocation on track, and maintains risk levels under control.

Think of rebalancing as a disciplined strategy encouraging you to sell winning assets and buy losing assets. It’s that familiar “buy low, and sell high” in a different wrapper.

But how often should you rebalance? Is it once per year, once per quarter, or once per month?

And does rebalancing always help your portfolio, or could you actually be doing yourself harm by tinkering too much with the mix?

At a recent investment conference, Washington D.C.-area financial planner Michael Kitces made the case that too frequent rebalancing of client portfolios could actually be hurting performance.

We already know that trading too frequently can undermine results. Not only does it drive up trading costs, but jumping on short-term market swings can jeopardize meaningful long-term growth.

But intuitively, you can see why rebalancing can hurt growth. Rebalancing means “cutting your winners” (usually stocks) instead of letting them run. Many of our clients struggle with this concept. “It was doing so well,” they say. “Why did you have to sell some?”

It’s easy to forget there are very legitimate reasons to rebalance. A 50% stock/50% bond portfolio that is never rebalanced can easily morph into a 80% stock/20% bond portfolio. That’s like your house cat turning into an African lion; still a cat but with much bigger teeth.

Rebalancing helps keep your portfolio risk at manageable levels. Think of it as a way to minimize the damage during market pullbacks. Most investors saw portfolio values decline during the 2000 tech bubble and 2008 financial meltdown, but people who never rebalanced and had outsized tech or financial stock holdings suffered permanent and excruciating losses.

That’s why rebalancing is a prudent strategy to take some money off the table by realizing profits and deploying money elsewhere.

Here’s some rebalancing pointers:

Do review your portfolios periodically (quarterly is good) but don’t rebalance until portfolio allocations are truly out of whack. Prices move every day, and you don’t want to trade needlessly.

Need to withdraw money? “Sell the asset class that is up the most,” says Kitces. Adding money to your account? Buy more of what’s down the most, or is below target allocations.

 

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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