Rebalancing can help investors to stay on track with their long-term financial goals and investment objectives, particularly during times of market instability. Rebalancing can provide investors with peace of mind.
Example: If your portfolio is balanced between 60% stocks and 40% bonds, when stock prices increase and raise the percentage of stocks you should rebalance by selling stocks and buying bonds to bring your allocation back within its target range.
Asset Allocation
Your investment portfolio’s composition depends on balancing investment goals, holding period requirements and risk tolerance – with stock, bonds and cash equivalents all providing different levels of returns over time. Choosing your allocation wisely will lead to long-term success in your investments.
Balanced portfolios typically invest a significant portion of assets across stocks and bonds. This strategy is best suited for investors comfortable enduring price fluctuations with long-term goals in mind.
Investors strive to achieve higher returns with reduced risk, yet this cannot be accomplished without experiencing some degree of volatility in your portfolio. Rebalancing can help minimize this effect; selling investments that are over-weighted to use the proceeds towards buying more underweighted asset classes; this process can be performed using various techniques – transaction costs and taxes should also be taken into consideration when performing this exercise.
Rebalancing
Rebalancing involves purchasing and selling portions of your portfolio in order to realign its weightings with your desired asset allocation, thus helping minimize individual investments’ impact on overall risk tolerance and maintaining an even distribution over time.
Rebalancing does not guarantee higher returns, but it can help maintain better control over your portfolio’s volatility and boost its long-term return. Furthermore, it can prove especially helpful in times of market turmoil or financial distress.
Your advisor can assist in setting a rebalancing trigger based on the current composition and anticipated future performance of your portfolio, which could include setting a percentage or dollar threshold that must be rebalanced periodically. When making this decision, transaction costs and tax considerations such as brokerage fees, bid-ask spreads and taxes due on gains/losses should also be taken into account in making their selection; additionally, look for ways to minimize these expenses where possible.
Taxes
Taxes can have a major impact on investment plans, particularly when rebalancing taxable accounts. Rebalancing can incur transaction costs and generate capital gains taxes if you sell assets to bring your portfolio closer to its desired asset allocation target. Rebalancing within tax-advantaged accounts may reduce costs significantly.
Over time, market performance may cause your portfolio to deviate from its initial asset allocation plan. This may happen because different asset classes offer differing returns than others and thus altering their weighting in your portfolio.
Example: Say your portfolio had originally been allocated with 60-40 stocks-to-debt ratios; after a year of strong stock performance caused your equity exposure to rise to 60% and your debt exposure decreased, but then following “trailing” or “buy-to-sell,” rebalancing can become necessary to return it back to its initial state. Trailing, or buying-and-selling can reduce unnecessary trades and transaction costs associated with unnecessary rebalancing transactions.
Costs
Rebalancing can incur expenses, such as transaction fees for buying and selling securities, as well as opportunity costs such as selling high-performing investments to fund rebalancing purchases. But it should still be considered part of your overall investment strategy to help reach long-term goals more efficiently.
Rebalancing can help keep you on the path toward achieving the original plan that suits your age, needs and risk preferences. Rebalancing can reduce portfolio risk by decreasing how much money is tied into one asset class such as stocks.
Investors have the choice between rebalancing their portfolios on an annual or periodic basis, depending on their circumstances and costs. Rebalancing annually may be less expensive but may not respond appropriately to market fluctuations. By taking advantage of market trends by selling high-performing assets and investing in lower performing ones, long-term returns may increase significantly.