Rebalancing Your Portfolio: An Essential Step for Successful Investing

Portfolio Allocations

As you may know, asset allocation is the single most important factor that determines your long-term investing success. In a nutshell, asset allocation is the process of choosing what percentage of the dollars in your investment portfolio should go into which asset classes.

As the market goes up and down throughout the year, certain asset classes will perform better than others. That’s a primary reason to spread your dollars across various asset classes; it helps you manage risk.

However, the market’s ups and downs will also naturally alter the initial percentages you chose to invest in each asset class. To take a really broad example, if you had chosen to put 90 percent of your portfolio in stock-based investments and 10 percent in bond-based investments, a year in which the stock market outperforms the bond market may alter your initial 90/10 mix to 93/7.

At least once a year, you should “rebalance” your portfolio to bring it back to 90/10.

What Constitutes Your Portfolio?

If you have just one investment account, such as a workplace 401(k), that’s your portfolio. But what if you have multiple investment accounts – say a 401(k), and two brokerage accounts, one that holds your IRA and one that holds your spouse’s? It’s best to think of the entire collection of accounts as one portfolio. Here’s why.

First, it’s the easiest approach. Rather than going through the asset allocation exercise account by account and choosing multiple investments for each one, you only need to do so once.

Second, your investment choices may be more limited in one account than another, making it difficult if not impossible to get the ideal allocation in that account. So, you could use that account only to invest in one of the asset classes you need that’s available there and use a different account to invest in the other asset classes.

How Should You Rebalance Your Portfolio?

Assuming you’ve already decided on your ideal asset allocation (you’ll find various free online calculators, or you might want to use Morningstar’s Lifetime Allocation Indexes PDF), the first step for rebalancing is to see how your invested dollars are currently spread across various asset classes.

If you have a one-account portfolio, that account may tell you how your money is spread across asset classes. Or, if you’re using an online tool, such as at SigFig.com or PersonalCapital.com, to see a one-portfolio view of multiple investment accounts, such a tool may give you the information you need.

You could also do this manually, creating a spreadsheet that shows each investment (name of the fund and dollar amount invested), its asset class, and what percentage of your total portfolio that constitutes.

Next, compare the current allocations with your ideal asset allocation.

Last, sell down investments in asset classes that have become over-weighted vs. the ideal and transfer those dollars to investments in asset classes that have become under-weighted.

An Example

At Sound Mind Investing, we recommend that a young person who is not overly risk-averse build a 100 percent stock-based portfolio that’s allocated as follows for 2013:

  • 20% Foreign
  • 16% Small company growth
  • 18% Small company value
  • 22% Large company growth
  • 24% Large company value

If investments in the foreign and large company growth asset classes outperform the other asset classes this year, the percentage of this person’s portfolio in those two asset classes will be higher than their ideals by the end of the year while the other three will be lower. So, at the end of the year or at the start of next year, he or she should rebalance the portfolio to bring it back in line with the target allocations.

A Necessary Step

It’s surprising but true that getting the asset allocation right for your age and risk tolerance is a more important determinant of your long-term investing success than the specific investments you choose. So, make sure you rebalance your portfolio at least once a year.

How often do you rebalance your portfolio? Need to more often? Leave a comment and tell us what you think!











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3 Comments
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  1. There is one factor to always keep in mind with any balancing, and that is the economic cycle. Joseph gave Pharaoh a unique insight into the future, which enabled the ruler to implement a unique strategy to survive the coming famine. We live in a different kind of society today, but there is one thing we know: there is another famine (recession) coming.

    There always is. If you look at this chart: http://bit.ly/economy_chart you can see the facts.

    That chart shows the U.S. economy suffers a recession, like clockwork, every 7-10 years. Think of this chart as your personal “Joseph adviser.” This phenomenon goes back more than a hundred years. You don’t need to be Joseph or a rocket scientist to know you need to balance your portfolio out of just about any asset and into as much cash as possible, and after the (inevitable next) crash, put as much of your assets into appreciating assets, such as stocks or properties or whatever it is you invest in.

  2. What do you think about investing in gold– not just paper gold, but coins. It seems to out perform stocks every time.

    • Marion – At Sound Mind Investing, we have long seen gold as a wise investment for a portion of one’s portfolio – typically 5-10%. And we have typically favored holding physical gold. That said, we just announced a new investment strategy, Dynamic Asset Allocation (http://www.soundmindinvesting.com/vblog/an-investment-strategy-for-such-a-time-as-this/), that rotates among 6 asset classes, including gold (purchased through an ETF). Ultimately, each investor has to make decisions based on their time frame and risk tolerance, but we do think there’s a solid case to be made for holding gold as a portion of most people’s portfolios.

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