Why Investors Should Rebalance Their Portfolios
Dean A. from Los Angeles, CA asks: Mitch, I’d like to hear your thoughts on portfolio rebalancing. Whether rebalancing is important, how often should a retired person do it, what are some of the important things to consider when rebalancing, and so on. Thank you for your time.
Thank you for emailing your question, Dean. The short answer to your question is that rebalancing is a very important part of portfolio management, and there are not very many good reasons to avoid doing it. Investors should rebalance at least once a year, but maybe more if market conditions warrant.
Rebalancing is important for a variety of reasons, but perhaps most importantly, it ensures that an investor’s portfolio allocation remains in line with that person’s recommended allocation. In other words, if an investor’s goals, risk tolerance, time horizon, and income needs generate a recommended asset allocation of 70% U.S. stocks, 20% investment-grade corporate bonds, and 10% municipal bonds, rebalancing can ensure those exposures remain consistent.1
For investors nearing retirement, it’s common for market ups and downs to cause you to worry and become uncertain about your financial future. Our advice is to put in the time and effort! The key is to define your investment objectives, determine your asset allocation, and manage your investments over time.
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To the second part of your question, I would say that rebalancing is important for all investors but especially those in retirement. That’s when risk management is critical, and it’s also when some of the consequences of not rebalancing – like becoming over-exposed to a particular asset class – can lead to adverse outcomes.
A recent example I saw from Vanguard showed that someone who retired five years ago with a portfolio of 60% global equities / 40% bonds and never rebalanced, would today have a 72% global equity / 28% bond portfolio. This jump in equity exposure may compromise a retiree’s plans for generating income, controlling volatility, or both. The act of rebalancing can bring the asset allocation back where it should be.
As for how often to rebalance, studies have shown over the years that there is no significant benefit from rebalancing every month, versus every quarter, versus every year. In my view, rebalancing once a year is generally sufficient, unless an investor’s goals or needs change along the way, or unless the fundamentals of the economy and market change in such a way that it makes sense to adjust the asset allocation. Otherwise, checking in from time to time is generally a good practice.
Even though rebalancing is a fairly straightforward and beneficial undertaking, only about 50% of retail investors do it, according to Vanguard. That figure, of course, is way too low, especially if some of those people are retired.
This brings up a final point – rebalancing in tax-deferred accounts like IRAs and 401(k)s is different than rebalancing in taxable brokerage accounts, due to capital gains considerations. I am of the mind that investors should not let the ‘tax tail wag the investment dog,’ but how you go about rebalancing every year should likely consider taxes. There may be strategic ways to minimize taxes while achieving the desired outcome at the same time.
Rebalancing your portfolio takes a lot of work and dedication, especially for those who are preparing for retirement. We want to share some additional steps to help protect your investments and create a portfolio that meets your financial goals. To help you do this, I recommend reading our guide, 7 Secrets to Building the Ultimate DIY Retirement Portfolio.3
If you have $500,000 or more to invest, get this guide to learn our ideas on the step-by-step process of building and maintaining a retirement portfolio that will potentially help you reach your goals and enjoy a secure retirement.
2 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
3 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
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