Rebalance Your Investment Portfolio

by Kevin on August 23, 2010

Living under your means and on a budget is a great first financial step. Building up an emergency fund is a byproduct of that first step and is definitely necessary.

But you and I know you can’t just stop there. One day, hopefully sooner rather than later, you’ll want to retire and live off the money you’ve saved up.

Investing for retirement is a huge step toward securing your financial future. Setting up automatic withdrawals is another huge step as it removes the emotional side of investing.

As great as these steps are you simply can’t stop there. You have to be active in maintaining your portfolio’s balance.

What is Rebalancing Your Portfolio?

Rebalancing your portfolio is the process of resetting the balance of stock mutual funds and bond mutual funds within the portfolio.

If you start investing at a young age you should most likely have a portfolio that is close to 100% stocks. But as you age you start to build in a mix of bonds to bring down the risk level in the portfolio.

As the year goes on the stock market goes up and down. Your stock mutual fund holdings change in value. If stocks have a great run your portfolio’s allocation gets thrown out of whack.

Let’s say you wanted to have a portfolio mix of 75% stock holdings and 25% bond holdings. You start the year with this allocation.

But as the year goes on, as with this year, stocks have a great run. Your overall portfolio is up and most of that growth is due to your stock holdings. Your allocation now sits at 83% stocks and 17% bonds. Your allocation is out of whack and needs to be rebalanced.

What is the Rebalancing Process?

The rebalancing process is simple. If you are sitting at 83% stock holdings and your target is 75% you sell some of the stock holdings. Take the proceeds from selling those stock holdings and buy more of your bond holdings.

Many providers of retirement accounts (your company 401k provider, your Roth IRA company of choice) make this process easy for you by providing a rebalancing tool.

Instead of having to figure out the actual dollar or share amounts that you need to sell you can just tell the provider to set you back to your targeted portfolio allocations.

This is what my 401k provider offers as an option:

how to rebalance your portfolioAs you can see if I were going to rebalance right now I would tell the company to get my holdings back to their elections rather than their current percentages.

Why You Should Rebalance?

Simply put: ignoring your investments will lead to your allocations getting out of line… and that usually doesn’t end well.

Imagine if your portfolio was supposed to be 50% stocks and 50% bonds leading into the financial crisis a few years ago. You had set your allocations back a while back, and through growth of your funds your allocations were actually 75% and 25% bonds.

When you checked your account one day you’d notice your stock allocations having fallen roughly 30% in a short period of time. You’d feel a lot better if only 50% of your holdings were in stocks instead of 75%.

Additional Rebalancing Thoughts

Rebalancing is really important. What questions do you have? Drop a comment and we’ll see if we can help.

One last thought: your retirement account provider may also provide you the option of automatic rebalancing on a set schedule. I highly recommend this — and I’ll tell you when you should set it to automatically rebalance in my next post.

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