Personal Finance

As markets soar, it may be time to rebalance your portfolio

Portfolio rebalancing
Portfolio rebalancing

The Trump rally is a perfect time to kick the tires on your retirement portfolio. Once you look under the hood, you may need to rebalance.

Rebalancing is the psychologically brutal process of selling your winners and buying your losers to maintain your portfolio's ideal mix of assets. It forces you to buy low and sell high.

"The biggest mistake clients make when markets break records is chase what is doing well and sell what isn't," said Gustavo Vega, a certified financial planner and private wealth advisor at Ameriprise Financial Services in Miami.

"They need to do the opposite, which is what rebalancing accomplishes."

Risk management may cause the portfolio to do slightly less than the market as they hear it on the news.
Mark Germain
CEO of Beacon Wealth Management

Here's how rebalancing works: Let's say you have a portfolio with a target allocation of 50 percent in large company stocks and 50 percent in small-company stocks. Then the large-company stocks rise 10 percent and small-company stocks fall 10 percent over time.

In this scenario, you would have a portfolio of 55 percent in large-company stocks and 45 percent in small-company stocks. So you'd need to sell the rising large-company stocks and buy the small-company stocks to rebalance the portfolio to the allocation you originally wanted.

Rebalancing may not boost your returns, especially in the short run.

"Risk management may cause the portfolio to do slightly less than the market as they hear it on the news," said Mark Germain, a CFP and CEO of Beacon Wealth Management in Hackensack, New Jersey. "Exuberance may create a little discontent, and then reality will set in when the market dips and the clients' portfolios were rebalanced to withstand the downturn."

Find your rebalancing strategy

There is no ironclad formula to rebalancing. It all depends on how comfortable you are with your portfolio deviating from its target allocation.

Some investors rebalance portfolios quarterly, semi-annually or annually. Others prefer to rebalance only when a portfolio mix strays beyond a by a predetermined minimum percentage — such as 1 percent, 5 percent or 10 percent — of a target allocation.

"With the stock market reaching new highs, we are not recommending any changes and continue to rebalance clients' portfolios once a year," said Cynthia Turkington, a CFP and founder of Fair Trust Financial in North Oaks, Minnesota. "When you rebalance once a year, it minimizes trading costs."

Don't forget about taxes when you rebalance. "Think about harvesting some tax losses for this calendar year so that you maximize the impact if tax rates decrease next year," said Allan Katz, a CFP and founder of Comprehensive Wealth Management Group in New York.

The best rebalancing strategy is the one you understand and feel good about and can consistently execute.

A 2015 Vanguard study analyzed the impact of rebalancing on the performance of several hypothetical portfolios from 1926 through 2014.

Vanguard analysts concluded that "just as there is no universally optimal asset allocation, there is no universally optimal rebalancing strategy. The only clear advantage so far as maintaining a portfolio's risk-and-return characteristics is that a rebalanced portfolio more closely aligns with the characteristics of the target asset allocation than with a never-rebalanced portfolio."