Maintaining the right mixture of assets in your portfolio is important to your long-term investment success. Because some investments go up in value over time, and others go down, experts recommend periodically rebalancing your portfolio so that you don’t end up owning too much of some securities and not enough of others. But when—and how often—should investments be rebalanced?
First and foremost, rebalancing should never be a reaction to short-term market conditions or news. It can be too easy to justify attempted market-timing as portfolio rebalancing. For that reason, it’s necessary to establish your rebalancing criteria in advance.
There are two main strategies for rebalancing:
With this approach, you take the time variable out of it. Rather than scheduling your rebalancing for a specific date, you instead monitor your portfolio and rebalance when it has changed by a certain amount. For example, you could decide to rebalance once any one asset class is more than 20% away from its initial target. If your portfolio called for 40% in large cap stocks, then you would rebalance whenever you had a 48% allocation to large cap stocks. The advantage of this method is that it prevents an increase in portfolio risk by initiating a rebalance as soon as the deviation changes the risk. One downside of this method is that in volatile markets, it can lead to frequent rebalancing.
The other approach for rebalancing is time-based. With this method, you choose specific time intervals to rebalance. The advantage of this method is that it doesn’t require you to monitor your portfolio between scheduled rebalancings, a definite advantage for those who tend to have difficulty not reacting to every rise and fall in the markets.
Exactly how often to rebalance, however, is a matter of debate. Without the benefit of flat-fee pricing (such as Folio’s Unlimited Plan) rebalancing too often generates higher transaction costs. It also generates the potential for taxable events. Some experts recommend the “birthday method,” so-called because you use your birthday as reminder to rebalance annually. Others recommend quarterly. Whatever method you choose, be sure to set the proper reminders so you don’t forget.
Many investors neglect to rebalance as often as they should because for many, it can be time consuming and complicated. But with Folio’s trading tools, you can set your portfolio to equal weights, market or market-cap weights, or the weights of your own choosing, and then rebalance with a single click.