December Investment Tasks: Portfolio Rebalancing

With December upon us, and 2023 nearly at end, investors might find this an ideal time to review their portfolio holdings and make necessary rebalancing changes for long term goals. This article will review the importance of rebalancing and how to accomplish this crucial portfolio management task.

Rebalancing is the process of restoring original target allocations to your desired risk level. That is, for an investor choosing a simple allocation target of 60% equities/40% bonds, without an eye on regular rebalancing, their current portfolio allocation might now be approaching 80% equites/20% bonds. For this investor, their portfolio has ‘drifted’ to unacceptable allocations of equity versus bond based on risk level. By rebalancing, this investor is able to reduce the chances for disproportionate losses if the equity market experiences large downward price swings. 

Rebalancing also has the additional benefit of helping investors to ‘buy low and sell high.’  From our example above, where the current equity allocation has risen to 80% due to upward equity prices, rebalancing the portfolio to the desired 60%/40% mix allows this investor to ‘sell high,’ reducing his equity allocation, and ‘buy low’ while reinvesting into the bond allocation. 

Rebalancing does take discipline. It’s not always easy to sell some of the better performers to purchase those who lagged behind. Rebalancing can also create a capital gains tax liability when selling securities from profitable positions. This liability can be at least partially offset by rebalancing in tax-deferred accounts.  However, it’s imperative the investor embrace that rebalancing is a calculated decision meant to manage portfolio risk, and in the long-run, to assist in an effort to reach long-term goals.

Here are 5 steps that will help an investor implement a rebalancing plan:

Step 1: Determine your asset allocation targets: What allocation of stock/bond/cash is right for you? Not sure? Consider reviewing the asset allocation of target-date mutual funds geared towards individuals in your age group. Such information is widely available on web sites, such as Morningstar, Vanguard and Fidelity. You’ll likely also find questionnaires that you can complete for insight into the allocation targets that are commensurate with your risk tolerance and growth needs.

Step 2: Determine your current asset allocation: Organize investment statements so you can determine your current allocations. Do you understand the composition of your mutual funds and exchange traded funds? How do these overlap with any individual stock holdings? Review your holdings closely to identify how you are currently allocated by stocks, bonds and short-term reserves.

Step 3: Review your individual holdings: Use available research tools to review/analyze current holdings to spot early warnings signs. Examine performance, short and long term results. Which of your holdings are having the biggest impact on your portfolio performance? Always be sure to think about the tax consequences of any sell decisions while rebalancing. Collectively consider other portfolios you may be managing.

Step 4: Implement your rebalancing plan: Identify a rebalancing threshold, 5-10% off allocation targets, and then identify where current allocations need trimming. Shift/rebalance money from those asset types that have performed well and reinvest into your portfolio underachievers, using dollar cost averaging where appropriate. Continually review allocation to stay in line with your target allocation of stocks, bonds and short-term reserves.

Step 5: Make it a habit to periodically rebalance your portfolios: Set a schedule – 1 or 2x’s per year. At the start of a new year, end of the current year, or multiple times during the year – whatever schedule that works best for you.  Setting and sticking to a disciplined rebalancing schedule will help keep your allocations in line with your risk tolerance and long-term goals.

The benefits of portfolio rebalancing are many. Focusing on this important concept of portfolio management helps to prevent overly concentrated portfolios, reduces overall portfolio risk, adds discipline to the management process and helps avoid emotional decision making. Proper rebalancing is a cornerstone of good portfolio management, and is an important portfolio management task all investors should regularly perform.

Investment Account Manager, a windows based desktop software program for portfolio management, includes many tools that enable investors to identify tax saving maneuvers.

A free 60 day demo version (no credit card required) is available on our website: Investment Account Manager

Posted on December 1, 2023
Your trusted partner since 1985.