Portfolio shifts are a common occurrence for investors, especially active ones. Over time, assets shift out of balance from their original assigned portions and could take you out of your comfort zone. Rebalancing your portfolio realigns your assets to meet your goals according to a particular timeline and risk tolerance.
But the act of rebalancing has the potential to bear a hefty price tag, one that can break the bank through taxes, fees and time consumption. The good news? Experts at Vanguard have done their due diligence and have reached an opinion on the subject to provide you with the best answer to “When should I rebalance my portfolio?”.
For a guidance on rebalancing your portfolio, connect with a financial advisor for free.
Why Rebalance Your Portfolio At All?
Investors use rebalancing to restore their assets to their original allocations, adjust assets for their risk tolerance and optimize portfolio performance. Here’s what each of those looks like.
Restore original proportions: When the initial investment was made, you chose how much of an asset to purchase and add to your portfolio based on your risk tolerance and earning goals. This was the original asset allocation. Over time you continued to either reinvest the earnings, add more funding to your top performers, or sell off underperformers. Doing this adjusted the portioning of your assets. A rebalance will restore the portfolio back to its original state.
Risk tolerance: Your tolerance for risk can shift depending on age, finances, or market conditions to name a few. A rebalance can adjust your portfolio to your new level of comfortable risk. Either by being more conservative or advantageous.
Optimize performance: Over time, you may notice assets outperforming others. This can trigger a desire to shift your asset allocation in favor of creating additional space for more of the top performers and less of the lacking assets. Investors can use rebalancing to accomplish this.
Without rebalancing, the portfolio is allowed to gain or lose with no checks in place. Often times this results in a portfolio that loses more than it should and earn less than it could.
Costs of Rebalancing a Portfolio
Rebalancing comes with fees, time consumption and the potential risk of making a poor portfolio decision that will cost you down the road. Here are some examples of common ways these costs can occur.
Monetary cost: Anytime you buy or sell an asset you could be tacked with a fee that is due upfront. Also, some assets contain management fees which also add to the bill. Then you have capital gains taxes which can be a large chunk of your earnings if you sell within a year of purchase.
Time consumption: Rebalancing requires careful consideration of historical asset performance, predictive analysis and research to make a calculated decision on what to buy and sell. Rushing the process by guessing may save you some time but won’t help in the monetary cost section.
Risk of reckless decision-making: Rebalancing without the proper knowledge, insight and foresight can yield disastrous results. Those who rebalance too often could be replacing future top performers or adding low-return assets to an otherwise strong portfolio.
How Often Should You Rebalance Your Portfolio?
According to the experts at Vanguard, if you had to apply a standard rebalance schedule for any portfolio, odds are an annual rebalance would yield the best results a majority of the time.
While you can choose to rebalance on any schedule, an annual basis lets you avoid most high transaction costs and reap the equity from the assets.
The Bottom Line
Rebalancing too often can increase costs in capital gains taxes and trading fees. Rebalancing infrequently can decrease your earning potential while simultaneously drifting asset allocation out of your risk tolerance comfort zone. Annual rebalancing is the best-case scenario in most cases, even when the market is in trouble like it has been in recent years.
Tips on Investing
If you’d like help with your portfolio, whether rebalancing or otherwise, consider working with a financial advisor. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s asset allocation calculator to help you balance and rebalance your portfolio.
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