What is Portfolio Rebalancing? In this video, George Padula, CIO @ Modera Wealth Management, discusses the rebalancing process and the benefits of portfolio rebalancing.

Portfolio rebalancing is a key financial strategy used to maintain a desired level of asset allocation or risk in an investment portfolio over time. As investments increase or decrease in value due to market fluctuations, the original allocation percentages of different asset classes (e.g., stocks, bonds, cash, etc.) in a portfolio can shift. Rebalancing involves buying or selling assets in your portfolio to return to your original asset allocation targets or to adjust those targets to align with changes in your investment goals or risk tolerance.

Why Rebalance?

Maintain Risk Level: The primary purpose of rebalancing is to control risk. For example, if the stock portion of your portfolio grows significantly during a bull market, it might represent a larger percentage of your portfolio than you initially intended, increasing your exposure to stock market volatility.

Discipline and Removing Emotion: Rebalancing enforces a disciplined approach to buying low and selling high. It requires selling assets that have performed well and are possibly overvalued (and thus have a higher risk of decline) and buying assets that have underperformed and may be undervalued (and thus potentially have a higher chance of increasing in value).

How to Rebalance:

Review Your Portfolio: Determine your current asset allocation and compare it with your target allocation to identify which asset classes are out of balance.

Decide on a Rebalancing Strategy: There are different methods for rebalancing. Some investors rebalance on a regular time schedule (e.g., annually, semi-annually), while others do so when the allocation to an asset class shifts by a certain percentage (e.g., 5% more or less than the target allocation).

Executing Trades: Based on the rebalancing strategy, you may need to sell off portions of over-weighted asset classes and use the proceeds to purchase more of the under-weighted assets. In tax-advantaged accounts like 401(k)s or IRAs, this is straightforward. In taxable accounts, consider the tax implications of any trades.

Reinvesting Dividends and Gains: Some investors use dividends and capital gains distributions to help maintain balance by reinvesting them in under-weighted asset classes.

Considerations:

Costs: Be mindful of transaction fees and tax implications (for taxable accounts) associated with selling assets.

Tax Efficiency: In taxable accounts, consider strategies such as tax-loss harvesting to offset gains with losses and minimize tax liabilities.

Flexibility: While having a rebalancing strategy is important, it’s also crucial to be flexible and consider the current market environment and economic outlook.

Portfolio rebalancing is a fundamental concept in investment management that helps investors stick to their investment strategy and manage risk over time, ensuring that their investment portfolio continues to meet their financial goals and risk tolerance.

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