What Does “Rebalancing” a Portfolio Mean?
Once you finally finish building your portfolio of mutual funds, you will need to perform some maintenance periodically, even if you are a buy-and-hold investor. Rebalancing a mutual fund portfolio is simply the process of redistributing the investor’s current investments back to the original investments.
Rebalancing and Asset Allocation
Before considering rebalancing, you may want to revisit your allocation. A balanced investment portfolio consists of an asset allocation and core types of investments. For example, an investor might start with an asset allocation of 80% in stocks and 20% in bonds. Within this allocation, the investor may have 5 mutual funds, such as 4 stock funds with a 20% allocation each and one bond fund at 20%. This allocation or balance depends on the investor’s risk tolerance and investment objective (i.e., the reason for investing and the investment time frame).
Why Should You Rebalance Your Portfolio?
The reason investors rebalance their portfolios in the first place is important to understand. Often, some mutual funds or types of mutual funds perform better than others over a certain period of time. For example, over a one-year period, assume that your stock funds perform excellently while your bond funds perform poorly.
If your original allocation was 80% stocks and 20% bonds, your year-end allocation may now be 90% stocks and 10% bonds. You are now out of balance, and this new, more aggressive allocation may expose you to unwanted risks. Conversely, if stocks are performing poorly and bonds are performing well, you may be taking on less risk in the following year and may miss out on opportunities to benefit from stock market gains.
To rebalance, you simply make the necessary trades to return your mutual funds to their targeted allocation. For example, if we return to the example of the investment portfolio consisting of 5 funds, you would buy and sell shares of the appropriate funds to return to the original allocation of 20% for each fund.
Of course, you will sell shares of the funds that performed well during the year to bring them back to 20% and buy shares of the funds that performed poorly until they are back to 20%. You’ve sold the winners and bought the losers – a sound investment strategy.
How Often Should You Rebalance Your Portfolio?
Your portfolio should not need rebalancing frequently because large market fluctuations rarely cause significant changes in your original allocation ratios for your mutual fund portfolio. If you allocate 20% to a specific fund, it’s rare for it to change by 3 or 4 points in a year.
Additionally, there may be trading costs associated with buying and selling funds. Thus, rebalancing too often can diminish the potential positive effects of doing so. Once a year is a sufficient frequency to rebalance your mutual fund portfolio. Many people do this at the end of the year when it makes sense to consider other year-end strategies, such as tax-loss harvesting.
You can also choose a memorable date, such as an anniversary or birthday. Also, before rebalancing, ensure that your financial outlook and investment goals have not changed in a way that necessitates a change in your asset allocation.
Conclusion
Typically, there is a need to rebalance a mutual fund portfolio once a year. This is because financial markets do not usually experience significant price volatility over short periods of time. Some account management tools with online brokerage accounts and mutual fund companies or 401(k) plan sites may offer options for automatic rebalancing.
Source:
https://www.thebalancemoney.com/how-and-when-to-rebalance-your-portfolio-2466529
}@media screen and (max-width: 480px) {
.lwrp.link-whisper-related-posts{
}
.lwrp .lwrp-title{
}.lwrp .lwrp-description{
}
.lwrp .lwrp-list-multi-container{
flex-direction: column;
}
.lwrp .lwrp-list-multi-container ul.lwrp-list{
margin-top: 0px;
margin-bottom: 0px;
padding-top: 0px;
padding-bottom: 0px;
}
.lwrp .lwrp-list-double,
.lwrp .lwrp-list-triple{
width: 100%;
}
.lwrp .lwrp-list-row-container{
justify-content: initial;
flex-direction: column;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: 100%;
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
};
}
Leave a Reply