Why You Should Rebalance Your Portfolio

Thanksgiving weekend is the perfect opportunity to check your asset allocation.


One of the most important things an investor needs to do is examine his or her portfolio and rebalance it at least once a year. If you haven't rebalanced your portfolio this year, then it's time to check out how your investments are doing.

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Asset allocation. For a long-term goal like saving for retirement, an investor needs a road map. For most of us, that road map is our asset allocation. Your risk tolerance and investment time frame generally determine your asset allocation. If you are near retirement, then a lot of your assets should be in low risk investments like bonds. For younger people with a longer investment time frame and higher risk tolerance, stocks are usually the way to go. If you need help in figuring out your ideal asset allocation, a fee-for-service financial adviser can probably help you.

Rebalance. It's important to check on your portfolio at least once a year to see if your asset allocation is still on target. In 2011, stocks did not do well and it is very likely that your portfolio is heavy with bonds. There are two easy ways to rebalance your portfolio:

  1. Send new contributions toward the under-weighted holding throughout the year.
  2. Sell some holdings and rebalance the asset allocation.
  3. An investor can steer their portfolio to their target allocation using both of these methods.

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    Sell high, buy low. By rebalancing your portfolio, you will automatically sell high and buy low. In 2010, small cap U.S. stocks had a great year and gained over 20 percent. If an investor had rebalanced their portfolio, then they would have sold some small cap stocks in 2010 and then redistributed the gain to other low performance asset classes such as bonds, which had a negative 2 percent return in 2010.

    Year-end review. This year, bonds did quite well and stocks went down. If you sold some small cap stocks in 2010 and also purchased some bonds, then you would have locked in some gain and done better than investors who did not rebalance their portfolio.

    Retirement planning. Retirement is a long-term goal and the advantage of rebalancing your portfolio each year is cumulative. If an investor continues to sell high and buy low every year, then they have a better chance of building up a larger nest egg. It is also important to evaluate your asset allocation periodically. When you get closer to retirement, you will most likely have less risk tolerance and will need to adjust your asset allocation accordingly.

    [See Deciding How Much to Contribute to a 401(k).]

    Most of us procrastinate and put off rebalancing. If you haven't rebalanced your portfolio this year, this long Thanksgiving weekend is the perfect opportunity to check your asset allocation. If it’s out of balance, then you have the rest of the year to fix it.

    Joe Udo is planning an exit strategy from his corporate job by reducing expenses and increasing passive income. He blogs about his journey to early retirement at Retire by 40.