One of the biggest challenges of a smart investment strategy is setting up an asset allocation that properly aligns with your risk tolerance and financial goals. And while that is an important step, it most certainly isn’t the last one.
Your asset allocation is not a set-it-and-forget-it scenario. Instead of remaining idle until you decide it’s time to make a change to any of your positions, your asset allocation will regularly shift based on which investments are performing the way you envisioned them to, or not to, within your portfolio.
[See: 7 Tips for Finding the Best Target-Date Funds to Buy.]
Conducting a portfolio rebalancing exercise enables you to evaluate these shifts and buy and sell investments in order to restore your asset allocation to the proper ranges.
What are some of the primary reasons to rebalance your portfolio? The key to a successful investment strategy is a diversified portfolio and maintaining a long-term view. When emotions drive portfolio selection or investors obsessively chase returns by attempting to time the market, they usually end up disappointed. Just as diversification will help protect you from market shocks and resulting losses from any single type of investment, rebalancing your portfolio will similarly ensure that you aren’t overexposed to a certain area of risk.
If you are taking a long-term, disciplined approach but find that your asset allocation has become skewed over time, you can use a rebalancing exercise to get back to your original allocation, which should align with the level of risk that you are comfortable with. For example, if you start with the traditional 60/40 portfolio (which puts 60 percent of your assets in stocks and 40 percent in bonds) and find that by the end of the year it has drifted to a different ratio, you can rebalance to get back to the allocation that aligns with your risk tolerance.
A long-term investing strategy doesn’t mean that you can’t take current market factors into consideration when rebalancing. You may want to reposition yourself in a way that will enable you to take advantage of investments that could potentially outperform in the upcoming year. Be sure to assess current economic conditions to determine whether or not there are any asset classes, sectors or market caps where you want to increase or decrease your exposure.
With that said, you should not rely too heavily on short-term events to make investment decisions. In 2017, the macroeconomic climate continues to slowly improve and corporate earnings are likely to remain modestly positive, providing support against sustained drawdowns. But as with 2016, a year in which Brexit and the U.S. presidential election outcome served as two big surprises for investors, markets may again be subjected to more volatile “X-factors” throughout the upcoming year.
[See: 7 of the Best Stocks to Buy for 2017.]
These situations could particularly arise in the form of further geopolitical events given upcoming elections in Europe and alliances such as NATO and the World Trade Organization facing potential disruption. When this type of short-term volatility occurs, many investors will inevitably panic and make immediate adjustments to their portfolios that could have negative consequences and prevent them from participating in an ensuing market rally.
Therefore, it is critical for long-term investors to stick with their long-term plan and ultimately be rewarded for their patience.
How often should you rebalance? Investors should ideally complete a total rebalancing of their portfolios once a year, or twice at the very most. This doesn’t mean that investors can’t make tactical adjustments to their portfolio throughout the year, however. If something major goes wrong in your portfolio or you have misjudged the allocation that is right for you, making the necessary tweaks is appropriate. It may prove beneficial to meet with a financial advisor or professional when making these decisions.
What other factors should inform the rebalancing exercise? Most often the primary rationale for portfolio rebalancing is to account for shifts in your portfolio due to market conditions and return to your desired asset allocation. But you will also need to adjust if your risk tolerance has changed due to age (typically individuals choose to take a more conservative approach as they get older) or other life events, such as a new medical condition or family situation.
It also is prudent to use rebalancing for tax-loss harvesting in your portfolio. Offsetting potential gains by capturing some losses can prove beneficial under the right circumstances.
[See: 7 Notable Quotes From Warren Buffett.]
In the end, it is important to keep your objectives and risks at hand when conducting a portfolio rebalancing exercise. Until we have a crystal ball that can predict short-term market movement, it will benefit investors to stay the course and adhere to a long-term investment strategy that aligns with their desired level of risk and financial goals.
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Should Your Portfolio Be a Balancing Act? originally appeared on usnews.com
