Nothing protects your investment portfolio better than regular maintenance. In financial terms, that’s known as rebalancing.
Like a car tune-up, the process—which should be done annually—verifies that your asset allocations continue to remain aligned with your original plan.
For example: assume that last year you had $100,000 to invest. You decided to allocate $50,000, or 50%, to stocks, and the remaining half to bonds. This represents a 50/50 asset allocation plan.
In reviewing the performance of your portfolio during the past year, you discover that your stocks performed remarkably well. Consequently, your original 50% or $50,000 in stocks is now valued at $70,000. Meanwhile your 50% or $50,000 in bonds remained unchanged.
The result: your asset allocation of 50/50 has changed to about 60/40. Your stock “weighting” has shifted and is now off balance from its original structure. If this continues, your asset allocation will eventually “drift” far enough away that you will have a completely different portfolio.
You can prevent that from happening by rebalancing. Sell $10,000 of stocks and use that money to buy $10,000 of bonds. You would now have $60,000 of stocks and the same amount in bonds. And your portfolio would be restored back to the 50/50 asset allocation you originally created.
But why should you sell high-performing stocks in exchange for bonds with lackluster growth?
Because those same stocks that rose dramatically last year can suddenly nosedive next year.
Remember, you wisely chose an asset mix based on your personal risk tolerance and long-term financial needs. Diversifying your asset allocations into two distinct classes created a sensible risk-reward ratio.
Whether you chose a 50/50, 60/40 or 70/30 asset allocation plan, the intention was to protect you from market volatility. By remaining vigilant about rebalancing those assets whenever needed, you will maintain that protection.
Another perk to rebalancing is that it prevents you from responding impulsively to sudden market changes. Instead, your commitment to protecting the structural integrity of your portfolio via routine rebalancing establishes a strategy based on logic, rather than emotion and fear.
Rebalancing does not have to be complicated, but there are factors to keep in mind. Consider fees and tax implications each time you plan to sell or trade assets. At times, it might be wiser to increase contributions to a new fund while reducing them to an older one instead of selling them off. Such a gradual rebalancing may help avoid triggering extra capital gains taxes.
At Silverman Financial, we help you stay on track. We develop an investment strategy that makes sense for you. We keep a record of your assets, monitor their performances, and review the allocations you selected. We meet with you regularly to guide your financial decisions and ensure that you remain on track to meet your financial needs and goals.