Rebalance Your Investment Portfolio and Asset Allocation Every Year

by Hank Coleman

I have to admit that I have not rebalanced my investment portfolio in years. I always seem to forget to mark a date on the calendar to look at my asset allocations and the balance that I have between stocks and bonds, their investment locations (foreign or domestic), and their capitalization.

Money Magazine and the Schwab Center for Financial Research recently found that $100,000 invested over 37 years in a 60/40 split between stocks and bonds would have ended with a balance of $2.5 million in your account without ever touching it again. But, if you property rebalanced your portfolio every year, you could have earned an extra $400,000 with all other things being equal. Asset allocation means dividing your assets on a percentage basis among different broad categories of investments, including stocks, bonds, and cash. Asset allocation is a strategy for reducing the risk associated with investing.

Rebalancing your investments can make the difference to your financial health. As we have all seen, some assets classes do better than others in some years while others have better years in the economy. One year small cap shares may be on a tear and other years might be best for international stocks. If you aim for a set balance between your asset classes and types of investments, then you might eventually be out of whack if you do not rebalance your portfolio.

Rebalancing your portfolio helps you trim down your holdings in the winners of your portfolio and buy the lower cost chares of other investments (stocks, bonds, and mutual funds) that have not done as well in the past year or so. For example, let’s say that you have a stock portfolio that is comprised of 50% large cap companies, 30% in mid size, and 20% in small caps. For simplicity sake, you have a portfolio worth $100,000.  If one year small caps have a gangbuster year and large caps are lagging, your portfolio might end the year with $40,000 in large caps, $30,000 in mid caps, and $30,000 in small cap stocks. Your asset allocation weights are now off. You have a 40%, 30%, and 30% split instead of your target split of 50%, 30%, and 20%. So, selling your winners and buying your “losers” will help rebalance your portfolio and put you back on track with your correct allocation percentages. It also reinforces the investing principle of buying low and selling high.

But, when should you rebalance? A lot of people like to rebalance right after the first of the New Year. A lot of mutual funds rebalance right as they are closing their books before the financial year ends.  I personally like to rebalance my portfolio on my birthday in hopes of remembering to actually do it, but as I have said before, I am notoriously bad about remembering to rebalance. What about you? When do you rebalance? How do you remember?

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{ 2 comments… read them below or add one }

Daddy Paul March 4, 2010 at 10:29 pm

Good read on a hard subject I was trying to write about.
This seems like a lot of work but I ran a spreadsheet on it and the most profitable time to rebalance is after the NASDAQ has moved 15 percent from the last time you rebalanced. This is only in a tax privileged account. In a 75/25 portfolio the difference was between 10 and 50 percent over a static portfolio for any 10 year period I studied.
Since I am a market timer I only rebalance in my wife’s account and yes I do that when the market has made a nice move up and when it has made a significant move down.

American Express Gold Card March 29, 2010 at 11:04 am

this subject does not seems familiar to all but all should understand the importance

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