- It's always smart to regularly assess how much risk you're taking on with your investments
- Rebalancing means adjusting your investments based on changes in the markets
- Rebalancing helps you buy low and sell high, which is the key to success
- Rebalancing helps you balance your risk exposure and uphold your financial plan
Rebalancing your portfolio is a terrific way to ensure you're taking on a comfortable amount of risk. Rebalancing means adjusting the amount of money you've invested in certain stocks, bonds, or any other asset to protect yourself from new risks caused by changes in the markets during the year.
Here's an example:
Let's say your portfolio consists of 60% stocks, 30% bonds, and 10% cash. At the end of the year, because of market fluctuations, let's say the value of your stocks has dropped and the value of your bonds has increased. Or, perhaps the value of your stocks hasn't gone up as much as your bonds. At this point, depending on your financial plan, your portfolio may be overly exposed to risk or not risky enough to yield much return. In order to ensure that your portfolio maintains a level of risk you're comfortable with, you now need to rebalance your portfolio. After rebalancing, your portfolio might consist of 55% stocks, 40% bonds, and 5% cash.
Why Selling Your Top Performer Is Smart
At first, this alteration might seem counterintuitive. You might think: “My bonds are doing great. My stocks, not so much. I should sell stocks and buy bonds, not the other way around.” On the surface, it might make sense to pour more of your money into the asset class that’s doing the best. History shows that for long-term investors, though, that strategy will hurt, not help, returns.
Why? Because by selling stocks that have declined in value and using the proceeds to buy bonds that have increased in value, you’re selling low (stocks) and buying high (bonds). That’s the opposite of what you should be doing.
Buy Low, Sell High
Instead, if you sell some of your bond holdings that have increased in value, you’re selling when those holdings are at a high value. Using that money to beef up the amount of equities in your portfolio means that you’re buying stocks at a discount. You’re buying low (stocks) and selling high (bonds), which is always the key to investing success.
Rebalancing not only ensures that you're buying low and selling high but also eliminates the temptation to time the market. Since we can’t consistently predict when an asset class has peaked, it’s impossible to know the optimum time to sell and maximize profits. By rebalancing your assets at least once a year, though, you’ll be taking full advantage of the movement of the markets. You’ll also be keeping your portfolio in line with your long-term financial plan, which of course is the ultimate goal.
Want To Know More?
If you're wondering how to rebalance your portfolio, a financial planner, such as a CFPⓇ professional from Facet Wealth, can help you understand the process and, more importantly, how to craft a custom financial plan that includes portfolio management and every facet of your financial life.