Having an investment strategy is a key part to any comprehensive financial plan. At a high-level , this includes setting a target mix of stocks vs. bonds for your portfolio. But how often should you be rebalancing back to your targets when things inevitably drift higher or lower ? E specially during an incredibly volatile year like 2020 where we’ve seen precipitous stock market drops followed by record highs later in the year – s hould you look to rebalance every week, month, or annually? How far off from the targets do you have to be to warrant a rebalance?

While there is no perfect solution, since no one can consistently time the stock market, there are certainly some rules of thumb you can use when deciding how often, or when to rebalance. Each financial advisor will have a different philosophy on this topic, and there are many appropriate answers depending on your personal situation. Here are some of Milestone’s suggestions on when to rebalance your portfolio.

Start with a plan

When working with investments you first need to begin with an investment strategy . This includes what sort of investments you are going to hold, and how much of each. This includes broad asset classes, like stocks and bonds , and subcategories such as large US stocks, small US stocks, international stocks, etc.

As financial advisors , we find the most difficult aspect of investment management for most people is managing their emotions. This includes getting attached to investments that increase in value or getting anxious when they decrease. It is understandable when a sizable portion of your wealth, and the prospect of your retirement, is tied to how your investments perform. However, using your emotions as a guide is almost always (unless you get lucky) a bad way to manage your investments.

Having a predetermined plan in place is an excellent way to try and take some of the emotion out of the investment process. Knowing how you are going to manage your investments when the market is going well, and when it is not, can help prevent you from making an irrevocable gut-based decision that may derail your retirement plan. To take yourself out of the equation further, working with a qualified financial planner can help you structure your investment plan and be an unbiased calming influence when the stock market gets rocky.

Why should you rebalance?

Different investments will perform better or worse at various times. When this inevitably happens, your investment portfolio will drift away from your intended targets when you started. This may make your portfolio more aggressive, or conservative, than you are comfortable with. Historically over the long-term, stocks have increased in value faster than bonds. But during the short-term stocks can fall in value incredibly quickly, even though historically temporarily, as we observed earlier this year.

The purpose of rebalancing is to periodically review your portfolio to bring it back to its intended investment targets. This helps keep your overall risk profile in check, so your entire portfolio is more likely to behave as expected when the stock market goes up and down. Rebalancing is also used as a way to take some profits when certain assets are up, and increasing your holdings when others are down. Knowing when this should be done all starts with having a plan in place before volatility, either up or down, strikes.

It is also important to note that rebalancing a portfolio of well-diversified mutual funds, is very different than one containing individual stocks, or narrow asset classes (ex: only technology companies, companies in Denmark, automobile manufacturers, etc.). When you invest in diversified investments, like a S&P 500 fund, you are spreading out the risk of your investments by not concentrating it in only a handful of companies or certain specific asset classes. This will limit any upside potential, but we believe much more importantly, you are also reducing your downside risk by spreading out your investments among numerous companies.

While past performance does not guarantee future results, historically the stock market has always increased in value over the long-term. The same cannot be said of every individual company. When rebalancing into a common, well diversified asset class, like large US companies (ex: S&P 500), there is historical data behind it, and although nothing is certain, based on the evidence we have it is likely to continue to increase over the long-term in the future. However, when rebalancing into something like individual stocks, a company’s future is not guaranteed. Selling individual companies that are doing well and buying ones that are not may mean that you are pouring money into a sinking ship. These rebalancing suggestions pertain much more to a well-diversified investment portfolio than one that is not.

How often should you rebalance?

Rebalancing is something that should be reviewed and done periodically for a portfolio. More so than a fixed rule, it is more of a Goldilocks mentality. Too often and you are incurring extra trading costs. Too infrequently and your portfolio could drift and become more conservative or aggressive than originally intended. Daily is too frequent, and annually may not be frequent enough. W hat makes the most sense for you, may be different for someone else.

For someone who is not a financial professional, and is managing their investments themselves, once a quarter may be appropriate for two reasons. First, if the stock market is not doing well and your balances have dropped considerabl y , at least in the near-term, you are not seeing it that often. Although we discussed having a plan in place to try to remove emotions as much as possible, it is something that is incredibly difficult to do, especially if you are not someone who deals with financial markets on a regular basis. This makes it less likely for you to make an emotional trading decision when reviewing your portfolio for rebalancing because you are not seeing it as often . Avoiding selling stocks when they have ( historically temporarily ) dropped in value is paramount when managing your investments. One way to help is not to not review your portfolio too often and make an irrevocable knee-jerk decision.

Secondly, since most people are not financial planners, reviewing investment portfolios is not something they would consider fun or exciting. Reviewing on c e a quarter is enough where you are not spending too much time reviewing your investments, but often enough to check in and make sure everything is still on track. Of course, if you are up to it, reviewing once a month is good as well, but once a quarter we find is also acceptable.

How far off should an investment be before rebalancing.

Another question to ask is whether you should rebalance every time you check, or only when investments drift too far from their intended target . Just like before, there is no fixed rule, and somewhere between too small and too large is a “just right.” If your target portfolio is 50% stocks and 50% bonds, and when you look to rebalance your stocks are up 1% (51%), it does not make sense to rebalance. Like before, when you are rebalancing after only a small movement, you are incurring additional trading costs. However, using the same example, if your stocks have drifted up to 90% of the portfolio and your risk tolerance has not changed, you need to rebalance back to your target allocation because the risk profile of your portfolio has changed substantially .

One example is to use a 20% variance from an asset’s target before considering rebalancing (EX: If an asset class’s target is 10%, you would look to rebalance if below 8%, or above 12%) . Some may use a 10%, 15%, or 25% variance and none of those are wrong answers either. The important thing is to have a plan, track how much an asset class is off target, and use this to help you determine whether to rebalance or not. Just because you are looking at your portfolio every quarter does not mean you need to rebalance every time.

Is rebalancing timing the stock market?

At Milestone, we believe it is impossible to time the market correctly and consistently . To do so you need to be right twice – o nce to get out of the stock market, and again to get back in. Structured, prudent rebalancing is not an attempt to time the market, but to bring a portfolio back to its intended risk profile. This means that you will be selling stocks when they have risen too high, and buying them when they are low, but based on a predetermined plan that matches your financial goals. An appropriate rebalancing strategy balances the risk you are taking with the returns you are trying to achieve.

Summary

Rebalancing is an important aspect of any financial plan , but you want to be sure you are not doing it too much or too little . We believe the best way to do this (in general) is to look often and trade infrequently.

Having an investment plan in place takes some of the emotion out of investing so that you are not making irreversible decisions when you are understandably concerned about a temporary decline, or exuberant from a large stock market rally. Rebalancing keeps your investment portfolio in balance by helping maintain a desired risk profile to help reach your overall financial goals.

Managing your investments and rebalancing can be challenging. If you would like help with your investment management, and your overall financial plan, please reach out to our team .