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What is portfolio rebalancing?

Portfolio rebalancing is a practice that aims to manage investment risk by maintaining target allocations over time. To clarify, target allocations refer to the percentage of Stocks, Bonds, cash or alternatives selected to balance your risk & needs when investing. Using the three major asset classes for the purposes of simplicity we will look at stocks, bonds and cash. Due to the risks involved on each of these parts of your portfolio they will not grow or drop at the same rates. Therefore, while the markets rise and fall your balances in each of these will take up more or less real estate than they were initially intended to causing ‘portfolio drift’.

Why is it Necessary?

Portfolio drift is a naturally occurring part of anyone’s portfolio that is not actively rebalanced. The graphic above shows an instance of portfolio drift in a growing market, where stocks are out-performing bonds. During this time the “target allocation” of 50% stocks, 45% Bonds and 5% cash has drifted to have 65% stocks, 30% bonds and 5% cash. As a result, your portfolio would be riskier than you had intended (and possibly could withstand) due to this drift.

How do I accomplish portfolio rebalancing?

Portfolio re-balancing is a practice where at a regular interval (weekly, monthly, quarterly) chosen by the investor or investment manager these balances are checked. If the allocation is outside a pre-determined threshold there will be a balancing out of the portfolio back to the target allocation. In our illustration above, 15% of the stock allocation would be sold off and re-invested into the bonds of the portfolio, bringing the allocation and risk level of the portfolio back to proper proportions.

What to watch for.

A common misconception is that your 401k stays balanced because you have chosen the allocation when you enrolled. This enrollment simply instructs how much of your savings goes into each of the investments. However, the market performance of each of those investments determines how much drift you have in one direction or another. Take a moment to check on your portfolios to discover where your allocation currently stands. Should you not have a ‘target allocation’ it is worthwhile to sit with one of our planners to discuss what would be most efficient for you.

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