As we passed the second quarter of 2024, our clients’ portfolios were reviewed for rebalancing. But what does rebalancing an account entail and why is that so important? Investopedia explains that rebalancing “involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation.”
Here are the two main reasons it’s important for your portfolio to be rebalanced each quarter:
- Risk Management
The main reason to rebalance a portfolio is to maintain the level of risk that each account owner initially established. Let’s say you opened a retirement account with $50,000 invested in stocks, and $50,000 in bonds. This would be a pretty safe 50/50 portfolio mix. Good news- over the course of a year, stocks performed very well. Your account balances are now $65,000 stocks and $51,000 bonds. This is great! However, you are no longer invested in the 50/50 portfolio mix that you initially decided on. Rebalancing is necessary to bring that back to 50/50 by selling off some stock and purchasing bonds.
- Buying Low and Selling High
Though not the main goal of rebalancing, doing this brings the added benefit of following one of the fundamental rules of investing: buy low and sell high. In the example above, rebalancing would force an advisor to sell the over weighted, overvalued stocks and purchase the underweighted, undervalued bonds. If, instead, stocks had performed poorly, then rebalancing would require purchasing the underweighted, undervalued stock. There is never a time where rebalancing forces you to buy high or sell low.
Rebalancing never seems like the right thing to do at the time. For example, in 2008 when stocks were plummeting, rebalancing would have been to sell safe fixed income to buy the stocks that were plummeting. If you think about it though, that would be buying low and selling high. Doing this maintains your original risk preference and can help to increase your return over the long term as well. Rebalancing “provides a systematic investment path that can curb destructive behavior” (matsonmoney.com). Make sure that your money is invested with an investment coach that has a scientific and predetermined way of rebalancing your hard earned money.
By Jimmy Hancock
References
- Strohbach, Corinne. “3 Reasons Why You Should Talk to Your Advisor about Rebalancing-Hint: It’s Not about Returns.” Matson Money, 17 Nov. 2022, www.matsonmoney.com/3-reasons-why-you-should-talk-to-your-advisor-about-rebalancing-hint-its-not-about-returns/.
- Manning, Liz. “Rebalancing: Definition, Why It’s Important, Types and Examples.” Investopedia, Investopedia, www.investopedia.com/terms/r/rebalancing.asp. Accessed 24 July 2024.