Simple actions can significantly impact the process of building and maintaining wealth. We’ve heard the saying, “Don’t put all your eggs in one basket.” Asset allocation is the process of diversifying investment assets across various categories such as stocks, bonds, real estate, etc. The goal is to reduce overall volatility, balanced risk/reward, and improve consistency of returns. Diversification means spreading out your investments and making sure that you are not overexposed to one asset class or area of the market. Portfolio rebalancing is a key component to a disciplined investment strategy. Portfolio rebalancing is the process of adjusting the asset allocation of a portfolio to ensure alignment with long-term goals and risk tolerance. It is widely accepted that over 90% of the variability of a portfolio’s returns is based on asset allocation.
Market movements can cause your asset allocation to drift over time, and what was once a 60% stock/40% bond portfolio, for example, can turn into an 80% stock/20% bond portfolio following a strong run for stocks. This is why periodically rebalancing your portfolio is essential to making sure that it is still aligned with your long-term goals. In this example, the investor is now taking on more risk than he or she originally intended. Pursuing a regular rebalancing process (such as an annual review) helps add discipline and helps remove emotion from the process, especially during volatile markets. Protecting profits and seizing opportunities presented by undervalued assets may help portfolios grow more consistently. Rebalancing should be holistic and based on your comprehensive portfolio, not singular accounts.
Investors frequently delay rebalancing due to expected tax implications. Rebalancing can be done strategically, which may help reduce negative tax impacts and may even provide tax benefits. Examples of strategic rebalancing include:
- Taking gains in retirement accounts
- Realizing losses in taxable accounts
- Gifting highly appreciated securities from taxable accounts to qualified charities- reference our previous Niantic Neighbors article “The Power of Gifting”
Rebalancing a portfolio is analogous to changing the oil in your car every 3,000 miles- it is not a task that takes significant time, but may have a major long-term impact. Following a regular process of reviewing your portfolio can help you remain on track to achieving your long-term goals and hopefully the financial security you deserve!
Sources:Nasdaq.com, 2024, www.nasdaq.com/articles/5-benefits-regularly-rebalancing-your-investment-portfolio; CFP Board of Standards https://www.letsmakeaplan.org/financial-topics/articles/asset-allocation/asset-allocation-101
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