Quick Guide to
REBALANCING YOUR INVESTMENTS
In a volatile market, don’t ignore this essential step.
Over the past year, investors have been treated to record highs in the stock market – while also watching stomach-churning drops. During volatile periods like these, it can be tempting to react quickly, buying or selling as the market rallies or plunges. Yet doing so can upset your carefully crafted investment plan. The opposite can also be true. Standing by while your portfolio gets pushed and pulled by the market can jeopardize your plan by exposing you to too much risk, or conversely, not enough potential for growth. The good news is that periodic “rebalancing” can help keep your investments on track regardless of market movements large or small. Rebalancing involves selling securities that have jumped in value and reinvesting the proceeds in securities that have not done as well. That might sound counterintuitive, but rebalancing helps keep you on track. How? By maintaining your desired mix of stocks, bonds, cash, and other investments. Figuring out a mix of assets that’s right for you is one of the most important financial decisions you will make. A financial planner or adviser can help with that. This guide won’t do that, but it will remind you why rebalancing is important – and explain how and when to do it.
Your Investment Mix
Why You Need to Rebalance
When and How to Rebalance
Setting It on Auto-Pilot
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Seek a Pro's Advice
Reviewing the mix of investments in your portfolio regularly – and adjusting as needed – is a key step toward meeting your financial goals. It’s usually a good idea to get professional guidance about this important strategy.
© November 2019 Kiplinger Washington Editors Inc.
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Your Optimal Investment Mix
You built your portfolio with certain goals in mind: retirement, your children’s college education, maybe even that dream house on a lake. Your targeted mix of stocks, bonds, cash, and other investments is designed to help you reach those goals. The allocation that’s right for you considers your time horizon, risk tolerance, financial situation, and other factors. For example, younger workers decades from retirement can afford to take more risk by investing heavily in stocks that may be volatile but have the greatest potential for growth over long periods. Older workers nearing retirement, though, have less time to recover from a prolonged market decline. They tend to hold less in stocks than their younger counterparts and more in bonds that offer greater stability. Here’s a common rule of thumb: To set a percentage allocation for stocks, subtract your age from 120. So, at age 40, you’d invest 80% in stocks and the remainder in some mix of bonds and cash. You can also use the asset allocation tool at 360FinancialLiteracy.org to calculate a customized asset allocation based on your age, your ability to tolerate risk, and several other factors.
Large-cap stocks
MID-cap stocks
SMALL-cap stocks
INTERNATIONAL stocks
Investment-grade corporate
High-yield bonds
TIPS
GOVERNMENT BONDS
Cash equivalents
STOCKS
BONDS
CASH
Market capitalization of more than $5 billion. Market capitalization is calculated as number of shares times share price.
Market capitalization between $1 billion and $5 billion. Market capitalization is calculated as number of shares times share price.
Market capitalization between $250 million and $1 billion. Market capitalization is calculated as number of shares times share price.
Companies located outside the United States.
Debt with a Standard & Poor’s rating between AAA and BBB.
Also called “junk bonds” with a Standard & Poor’s rating below BBB.
Treasury inflation-protected securities.
Treasury securities.
Short-term investment instruments such as savings and money market accounts that are highly liquid and very low risk.
Introduction
Why You Need To Rebalance
Put Rebalancing on Auto-pilot
Home page
A QUICK GUIDE TO REBALANCING YOUR INVESTMENTS
TAKING A NEW JOB
GETTING MARRIED OR DIVORCED
Receiving a big inheritance
Retiring earlier than expecteD
Over time, market changes can knock your investment mix off target. For instance, when stocks perform well, your stock holdings can grow – eventually making up a larger proportion of your portfolio than they did originally. Say you’ve accumulated a $100,000 portfolio, with $70,000 in stocks (70%) and $30,000 in bonds (30%). After a very good year for the stock market, the portfolio is worth $120,000, with $90,000 in stocks (75%) and $30,000 in bonds (25%). This increased allocation to stocks can expose you to more risk than you want. Similarly, when your bond allocation grows beyond your original target, it can make your portfolio too conservative to reach your long-term goals. When your portfolio is out of line with your original allocation, it may be time to rebalance. Rebalancing also offers an opportunity to review your investments. And it gives you a chance to identify some underperforming assets that you may want to replace. Or you may find that your goals have changed, prompting a broader shift in your asset allocation. For example:
What if your new job offers stock options? That may motivate you to cut back on the portion of your portfolio devoted to stocks.
Changes in marital status may affect how much you’ll need to save for retirement and may involve combining or splitting assets that subsequently need to be rebalanced to match new retirement goals.
You might opt for a more conservative portfolio now that you have less need for the growth that stocks can provide to reach your goals.
You may need to shift to a more conservative asset allocation if you have to tap your portfolio years ahead of schedule.
all at once
Slow and steady
There are two main ways to rebalance
Rebalancing too frequently can hurt overall performance because you may be charged fees every time you buy or sell an investment. Instead, keep it simple by considering one of the following strategies: On a set schedule. A general rule of thumb is to review your portfolio once or twice a year. Rebalancing periodically on a set schedule can help you avoid buying or selling impulsively during short-term market swings. The “tolerance band” method. While stock prices can fluctuate sharply on any given day or week, this short-term volatility can quickly correct itself. Still, longer-term market swings can have a big impact on your portfolio. With the tolerance band method of rebalancing, you set a threshold for percentage change in your asset allocation. Once your allocation shifts by that target (or more), it’s time to consider rebalancing. Say your bond allocation is set to 40%, and you’ve chosen a tolerance band of plus or minus 5%. When your bond allocation drops to 35% or jumps to 45%, it’s time to rebalance. With this method, you rebalance when your tolerance band is triggered, which could be every few months, every year, or even longer.
The quickest way to bring your asset allocation back in line is to sell investments that have done well and plow the proceeds back into those that have gone down or remained flat. For example, say your desired asset allocation is 60% stocks, 35% bonds and 5% cash. But after a long stock market rally, stocks now make up 70% of your portfolio, while bonds account for 25%. To get back to your original allocation, sell enough of your stocks to bring your stock holdings back down to 60% of your investments while reinvesting the proceeds into bonds so they once more make up 35% of your holdings.
For a longer-term approach, you can direct new contributions toward assets that have dropped below their target allocation. If your stocks have grown, say, to 70% of your portfolio, but you want an allocation of 60% in stocks, direct all new contributions to bonds until you gradually restore your original allocation.
Target-date funds (TDFs) have become popular with busy investors who want a professional to do all the investing and rebalancing for them. The funds are often included as an investment option in workplace retirement plans such as 401(k)s. You simply choose a fund that matches your expected year of retirement. For example, if you want to retire in 2050, you would invest in a TDF that uses 2050 as its target date. Once you’ve chosen a fund, a professional manager does the rest. The fund will be invested more aggressively in stocks when you’re young and gradually will become more conservative as your retirement date gets closer. This shift is often called the fund’s “glide path.” Here’s how a hypothetical “2050 Fund” might change its asset allocation over time.
THROUGH FUNDS
TO FUNDS
Of course, not all target date funds are the same. Each fund company sets its own path and timetable for moving into more conservative holdings. It’s also important to know whether it’s a “to” fund or a “through” fund.
domestic stock funds
international stock funds
bond funds
cash or equivalents
AT target date
41%
18%
30%
11%
10 years to target date
34%
38%
26%
2%
25 years to target date
10%
52%
These funds aim to reach their more conservative portfolio mix on your retirement date and stop adjusting asset allocations once they hit that target year.
These funds hit that final portfolio mix after the target date, taking fund holders through retirement and continuing to shift the asset mix over a predetermined number of years.