Insights + Resources

Why Regular Rebalancing Makes Sense

Nov 22, 2024

Everyone loves a winner. If an investment is successful, most people naturally want to stick with it. But is that the best approach? Here’s why rebalancing is key.

It may sound counterintuitive, but it may be possible to have too much of a good thing. Over time, the performance of different investments can shift a portfolio’s intent – and its risk profile. It’s a phenomenon sometimes referred to as “risk creep,” and it happens when a portfolio has its risk profile shift over time.

When deciding how to allocate investments, many start by taking into account their time horizon, risk tolerance, and specific goals. Next, individual investments are selected that pursue the overall objective. If all the investments selected had the same return, that balance – that allocation – would remain steady for a period of time. But if the investments have varying returns, over time, the portfolio may bear little resemblance to its original allocation.

Rebalancing is the process of restoring a portfolio to its original risk profile. Remember, asset allocation is an approach to help manage investment risk. Asset allocation does not guarantee against investment loss.

There are two ways to rebalance a portfolio.

The first is to use new money. When adding money to a portfolio, allocate these new funds to those assets or asset classes that have fallen. For example, if bonds have fallen from 40% of a portfolio to 30%, consider purchasing enough bonds to return them to their original 40% allocation. Diversification is an investment principle designed to manage risk. However, diversification does not guarantee against a loss.

The second way of rebalancing is to sell enough of the “winners” to buy more underperforming assets. Ironically, this type of rebalancing actually forces you to buy low and sell high.

Keep in mind, however, that the information in this material is not intended as tax advice, and may not be used for the purpose of avoiding any federal tax penalties. Please consult your tax professional before rebalancing. The process may result in a taxable event.

Periodically rebalancing your portfolio to match your desired risk tolerance is a sound practice regardless of the market conditions. Managing Director and Financial Advisor Ed Doughty recently posted a video on the importance of portfolio rebalancing.  One approach is to set a specific time each year to schedule an appointment to review your portfolio and determine if adjustments are appropriate. We would welcome the opportunity to sit and chat with you.

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