Rebalancing your Portfolio
Over time, the asset classes in your portfolio will grow or shrink as the markets
change. Your portfolio will slowly drift away from the plan you established and
reintroduce risk as certain investments become weighted heavier than others. Rebalancing
aims to periodically adjust your investments so that they match your asset allocation
plan again. Rebalancing also allows you to reanalyze the goals of your portfolio
and make changes to meet your new allocation plan. Rebalancing your portfolio reduces
risk, ensures your investments remain balanced to your specifications, and provides
an opportunity to keep everything on track as you progess.
After you have established your asset allocation plan and set up your portfolio,
the changes in prices from day to day will gradually change the allocation of your
existing investments. It is important to rebalance your portfolio on occasion to
reset the size of each asset to match your target plan. Rebalancing your portfolio
can occur in two ways: selling and buying until your assets match your allocation
plan or changing what assets you invest into in the future.
For tax-deferred accounts such as 401k plans or IRAs, selling and buying different
assets until your portfolio matches your asset allocation plan may be easier and
faster than trying to plan future purchases. For accounts that may suffer brokerage
fees or capital gains taxes, changing how you invest future contributions may save
you money in the long run. Rebalancing
on an annual basis ensures your assets constantly meet your risk tolerance and maintains
A sample portfolio with the owner's target asset allocation plan.
The same portfolio a year later. Changes in the markets have changed the allocations
owner will need to rebalance the portfolio to realign it with the risk expectations
Gradual conversion to safer investments
As you grow older, it is important that your asset allocation adjusts to ensure
your portfolio maintains its real value. If you continue to invest 5 years before
retirement the same way you invested 25 years earlier, you may be undertaking a
great deal of risk as your portfolio is subjected to short-term changes in the market.
To reduce the risk of losing value in your portfolio, your asset allocation should
gradually change towards a more conservative allocation of more bonds and less equities.
As you reach retirement age, it is important to have some of the portfolio in cash
assets such as a money market account to draw on for daily living and unexpected
events. While no portfolio ever needs to be entirely cash or bonds, the amount of
equities should decrease over time for most investors.
Target Retirement Funds
Many mutual fund companies have recently developed funds that have a predefined
asset allocation and automatically rebalance and grow more conservative as they
near their target date. Each fund is associated with a year in which the owner would
theoretically retire. As that date approaches, more and more of the fund becomes
bonds and other low risk investments. These funds are ideal for people who do not
want to spend a lot of time worrying about the optimal asset allocation or remembering
to rebalance every year. Many investors want a more customized portfolio or have
different risk tolerances than the target retirement funds provide and choose to
make their own allocation plan.
Tactical/Strategic Asset Allocation
Tactical Asset Allocation refers to moving assets or investing at a specific time
in order to leverage changes in the market. In all other forms of investing this
is called market timing. The theory behind Tactical Asset Allocation is that an
investor can take advantage of a dip in the market to invest in that sector or asset
class while it is bound to go up later. If someone feels the stock market is going
to be weak next year, he or she may change the asset allocation plan to include
more bonds and fewer stocks as a way to reduce risk. Just like with individual stock
market timing, Tactical Asset Allocation is unlikely to work as it requires insight
into future markets and active management of your portfolio.
Next: View sample portfolios to compare to your allocation
Page last modified 3/21/2012