Yo! Are You Out of Balance?

Yo! Are You Out of Balance?

Now, I’m no yoga instructor here to educate you about the benefits of self-care. Rather, today’s dive into the financial world is all about balance, or shall I say rebalancing.  If you’ve ever done any sort of investing, such as your 401(k), there is always a question about rebalancing your account. The question of the day is what, why, when, and how of rebalancing.

What Is Rebalancing?

First up, what is rebalancing in relevance to investment portfolios?  Rebalancing is simply a feature that at certain frequencies your portfolio will reconfigure itself back to your original portfolio.  For instance, and for simplicity’s sake, let’s say you have a portfolio of 50% stock fund and 50% bond fund (no I don’t recommend this).  If over time your stock portfolio grows faster than your bond portfolio than your account, make look more like a 70% stock allocation vs. a 30% bond allocation.  Rebalancing in this instance would sell 20% of your stock allocation and reallocate it back to your bond fund rebalancing you back to a 50/50 allocation you originally set up.

Why Rebalance?

Why rebalance?  The most obvious question to ask here is why is it utilized.  There are a few key benefits of why most investment advisors highly recommend doing some form of rebalancing.  The most obvious benefit is that you constantly maintain your appropriate risk level for investing.  For instance, a person who sets up their portfolio to be only 50% exposure to the stock market is generally more conservative by nature.  However, if we look at the example above, you can see that very quickly this conservative individual may be allocated in a much more aggressive (i.e. uncomfortable) way than they should be.

Another large benefit of rebalancing is a constant buy low sell high feature.  If you have a rebalancing setup this forces your account to take the “winnings” and repurpose them to the laggards.  Let’s say you have a 50% allocation to international equities and a 50% allocation to domestic equities.  Now, if your domestic equities have a great year/quarter etc., and grow to force your portfolio to an 80/20 allocation what effectively has happened?  In this example, your US equities grew much faster than your international equities.  This is a way to trim those excess higher-valued assets and put them in areas that have not had quite the runup of your other asset classes (effectively replacing lower-valued holdings with higher-valued holdings). 

How Often to Rebalance?

The next question to answer is the frequency of rebalancing.  Personally, I feel less strongly about how frequently one should rebalance than the fact that they are rebalancing.  There are tons of efficacy to rebalancing, much of which I’ve detailed above, but how often should one actually rebalance?  Usually, you have a handful of options when setting this up yourself in your 401(k) from quarterly, to annually and generally other options in between.  The “experts” suggest, as we do in our portfolios, that one rebalances quarterly to have the optimum effect.  I do believe this is best practice but take no umbrage in someone rebalancing less frequently.  Just know, that the less frequent the less aligned your portfolio will be with your stated goal.

Rebalancing is easy to set up and use.  It comes with a plethora of benefits and is used by most investment experts.  It can be a great way to keep you aligned with your vision and goals when it comes to your life savings.  I use it personally on all my portfolios and am sure glad I have.  Remember, it works equally well when markets are up and when markets are down.  I consider it a great equalizer.

As always stay wealthy, healthy, and happy.