- According to the Profit Sharing/401k Council of America, 80% of people don’t regularly rebalance their 401k contributions.
- In 1976, if you initially allocated 60% of your portfolio to equity funds and 40% to bond funds, and you never rebalanced the account, today almost 85% of your assets would be in equity funds and about 15% in bond funds.
- According to Consumer Reports, in 2003, a portfolio that was 60% stocks 40% bonds would have been 70% stocks and 30% bonds by 2007. If left alone by 2009 it would have swung closer to a 50/50 mix.
- Consumer Reports analyzed how three hypothetical portfolios would have performed from 2007 until now. All three started with $100,000 using 70% in a broad market stock fund and 30% in a bond fund.
- Rebalance annually = $9,358
- Left alone = $7,994
- Moved all to Bonds after market fell 20% = $5,174
When you began investing for retirement, you determined your goal, your acceptable level of risk, and the appropriate asset allocation to reach that target. As the years pass, your risk tolerance changes, assets increase and decrease in value, and your portfolio can deviate from your original allocation levels. It is necessary to rebalance our portfolios to keep them in line with our objectives. If you do not rebalance and one asset class in your portfolio becomes too large, you are inadvertently changing your risk profile.
First let’s understand the difference between rebalancing and reallocation. They are two very different concepts:
Rebalancing
Rebalancing is when you sell or buy funds in your portfolio, so that your asset allocation percentages remain consistent. If some of your funds are performing much better (or worse) than your other funds, you may need to rebalance to maintain the distribution and risk profile you desire. For example, if your Small Cap stock fund sees gains of 30%, while your Large Cap stock funds see gains of just 5%, you should no longer have the 75/25 split that your portfolio was designed to have.
Reallocation
Reallocation is when you change the percentage of assets invested in different asset classes. Older investors who are near their retirement goals and want to reduce their portfolio’s risk, commonly trim their holdings in equities and increase their holdings of bonds and cash. This is to avoid too much volatility in their portfolio. This is especially important the closer we are to retirement to preserve the wealth acquired over a lifetime of investing.
Strategies for Balancing
One way to balance a portfolio is to sell the assets that have grown and invest the proceeds into the other asset classes to bring the portfolio back to your desired ratios. For example, if you had a portfolio split 60% equities and 40% bonds, and over the past few years the equity portion of the allocation grew to 70% equities 30% bonds. A portion of the equities could be sold and reinvested in bonds to bring the asset allocation back to the levels you deemed appropriate for your risk level.
The difficult portion of this method is determining the tax liabilities associated with selling assets that have appreciated in value, and then reinvesting the proceeds. Also, transaction fees and commissions need to be accounted for when rebalancing. If the portfolio is only a small percentage away from your desired levels, we suggest you consider waiting to avoid excess fees and rebalancing too often. Another way to balance a portfolio is to use the funds that you are contributing monthly to purchase the asset class that is below specified levels and return that portion of the portfolio to the appropriate percentage. Assuming a 60/40 split, equities to bonds, and the equity portion had grown to 70%, all future monthly investments should be in the bond portion until you return the percentage to 40%. This ensures that the portfolio continues to grow and the asset allocation is returned to the correct levels.
This method also follows our dollar cost averaging strategy. If equities performed poorly for the year and their percentage in the portfolio dropped, an investor could purchase equities with their monthly contribution. This increases the equity percentage while a likely appreciation in equity prices could bring the portfolio value up as well. Additionally, fees and taxes could be minimized, as you may avoid capital gains from selling appreciated assets and reinvesting the proceeds.
Most investors ask, “Why am I selling some of my stocks that are performing well to buy more stocks that are performing not so well—especially when most advisers preach long-term holdings and not worrying about the day-to-day fluctuations?” It does seem a little backward, but remember that diversification is necessary. A long-term approach does not mean “set it and forget it.” The stock market is cyclical. Thus, some sectors outperform others during different economic cycles. While it is possible that Energy stocks outperform Technology stocks this year, it is very likely that things will be different next year.
When to Rebalance
One common practice is to rebalance your portfolio whenever one type of investment becomes more than 5% out of line. However, you need to watch your transaction fees and tax consequences. You do no want to rebalance so often that it becomes a detriment to your portfolio. You may consider rebalancing near year end, combining it with tax loss sales, also known as tax loss harvesting, and possibly minimize your capital gains.
Alternately, if you are rebalancing your 401(k), the process is easier and often without fees. Still, it is suggested you rebalance at least once a year, but no more than once a quarter. Many administrators provide websites that allow plan participants to easily modify their holdings throughout the year. Furthermore, many plan web portals have easy-to-read pie charts that compare the allocation that you set to how your investments have performed. Most plan websites have an option to “transfer funds” or even easier “rebalance.” These options allow you to sell shares of overweighted funds and reinvest the proceeds into underweighted funds, thus, returning your portfolio to its original allocation.
Rebalancing forces you to adhere to your investment strategy. At Henssler Financial we believe you should Live Ready, and that includes consulting your financial adviser if you are considering deviating from your strategy by not rebalancing your portfolio. For more information on asset allocation and rebalancing your portfolio, contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
