Asset allocation is dividing your portfolio between different investment asset classes such as stocks, bonds, and cash, as well as sub-assets such as small, large, and mid-cap stocks. Bonds and international investments, as well as growth and value stocks, are often part of a well-diversified portfolio.
To maintain your target asset allocation through the ups and downs of the market, it is important to periodically Review your portfolio for rebalancing. If the actual allocation of one or more asset classes differs from the target allocation by more than a specified amount, it is time to buy or sell holdings in this asset class to bring the allocation back. target level.
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Your portfolio should be periodically reviewed to see if rebalancing is needed. This should be done at least annually, more often as semiannually or quarterly as appropriate.
There are several reasons why portfolio rebalancing is important to investors.
Maintain a reasonable level of portfolio risk
One of the main goals of asset allocation is maintaining the right balance between the potential for downside risk versus the potential reward in your portfolio. Over time, the performance of the different asset classes represented in your portfolio will shift both up and down depending on economic and market conditions. We’ve definitely seen this in the market in 2022.
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Over time, these performance changes will cause your portfolio’s actual allocation to shift from your target allocation. This can cause you to risk too much or too little. After making significant gains in the market, you may find yourself over-allocated to stocks. This can put your portfolio at greater risk than you would like if the market goes down.
Tighten investment discipline
Having a regular rebalancing schedule requires a degree of discipline as an investor. With the stock market already experiencing heavy losses through 2022, periodic rebalancing will likely result in adding to your portfolio allocation to asset classes based on equity. This inherently forces you to “buy low”.
On the other side of the equation, during a strong bull market, you may want to skip your rebalancing regimen and simply let the winners go. This is great if it succeeds, but this approach can expose you to additional downside risk as the market inevitably reverses itself.
None of us are smarter than the market. This time is no different. Reviewing your portfolio for regular, periodic rebalancing can help avoid the temptation to think you’re smarter than the market. You are not.
A reason to review your portfolio
While long-term investors are not expected to review their investments on a daily basis, they should review their portfolio at regular defined intervals. This can be coupled with a regular rebalancing regimen.
In some cases, you can set some accounts for automatic rebalancing at a set interval. This is common with 401(k) accounts. That’s great, but you still need to review these accounts to make sure your investments align with your overall financial plan.
If you decide that semiannually is the right time to review your portfolio for rebalancing, set this time frame to the time frame for you to review portfolio performance own and the investments are kept in the portfolio to see if changes are needed.
Whether you stay with your current portfolio allocation or decide to adjust them, make sure to rebalance your portfolio to bring your asset allocation back to your target allocation.
An important part of your financial plan
Over time, as you review your progress toward achieving financial goals like retirement, saving for college, and other goals, you may find that you’re ahead of schedule, or perhaps you’re falling behind. fall a little behind you had hoped for.
Your investments play an important role in helping you achieve your financial goals. You may determine that your target asset allocation needs to be adjusted to accept more or less risk based on a review of your progress against your financial plan. Once this decision has been made and any changes to your asset allocation have been made, it is important to continue reviewing your asset allocation for possible rebalancing. for a predetermined amount of time as you did before.
Combine rebalancing with other missions
Rebalancing can be done in a number of ways beyond just selling investments in asset classes with a higher than desired allocation and buying investments in allotted asset classes.
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Allocate new money, including contributions to an employer-sponsored 401(k) or similar, to under-allocation asset classes. This can help avoid causing taxable gains in taxable accounts.
- Exploiting tax revenue loss in taxable accounts, as appropriate for your circumstances. The proceeds can be used to offset any capital gains realized this year, a portion can be used to offset other income if needed, and any unused losses can be recovered. switch to.
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Consider using shares of highly regarded securities as charitable donations to organizations that accept this type of donation. This can help reduce your allocation for an overallocated asset class. The market value of donated securities can be used as a charitable deduction if you list your taxes. Additionally, you won’t be subject to any capital gains tax if you do if the securities are sold at the actual gain.
Several studies have shown that asset allocation is a larger factor in portfolio returns than stock selection. For this and other reasons, periodically rebalancing your portfolio as needed is an important part of the investment process.
