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Is portfolio rebalancing essential or overrated?

Investors often hear the drumbeat for picking appropriate investments and minimizing costs, but it can drown out the ho-hum maintenance aspect of having a portfolio: rebalancing.

While financial advisors differ on how often they rebalance client portfolios, they generally agree it's important to remember why anybody bothers to do it in the first place.

"Rebalancing can be a good thing if it's done to get [investors] back to their optimal asset allocation," said certified financial planner Allan Moskowitz, principal of Transformative Wealth Management.

Balancing rebalancing
Peter Cade | Getty Images

In simple terms, rebalancing your portfolio brings your asset allocation — how you divvy up stocks, bonds and cash — back in line with the mix you determined made sense for you when you set it up. For instance, say you originally built a portfolio comprised of 60 percent stocks and 40 percent bonds. If a strong equity market leads to growth in the stock portion and you never rebalance, you could find that ratio standing at more like 90:10.

The problem with that, say advisors, is a stock-laden portfolio comes with more risk.

"If you can't handle volatility or you're in the withdrawal stage, it's far more important to protect your portfolio from wild swings," said John Gajkowski, CFP and co-founder of Money Managers Financial Group.

"You give up some of the upside but minimize much of the downside," he said.

On the other hand, if you have a high risk tolerance (how well you stomach volatile markets) and a long risk horizon (length of time until you need the money), a stock-heavy portfolio whose value zigs and zags might not bother you.

"If you are a long-term investor, you can handle volatility, and if you're in an accumulation phase, I believe rebalancing is much less important," Gajkowski said.

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Rebalancing also can take place at a deeper level than asset allocation if you are building your portfolio piece by piece. In other words, say that within the stock allocation, you start with those assets evenly distributed across five slices of the investing universe to represent diversification across both domestic and international stocks, along with a range of small-cap to large-cap stocks. If one of those slices outperforms the others, it has the same effect of skewing the tidy ratios you determined made sense.

And whether you're rebalancing at the asset-allocation level or within those asset classes, you get another benefit: profiting off gains from outperforming investments while paying lower prices for underperforming ones, whether the outperformers are on the stock side or the fixed-income side.

"It forces investors to buy low and sell high, which is how you make money investing," said Moskowitz of Transformative Wealth Management.

Financial advisors typically rebalance their clients' portfolios anywhere from quarterly to yearly, depending on the particular investments and the clients' goals.

CFP Dana Anspach, founder and CEO of Sensible Money, is among the financial advisors who think less is more.

"When you diet, do you step on the scale every half hour?" she said, repeating a quote she once read that resonated with her.

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For her clients, who are mostly retirees or those nearing retirement, Anspach uses a drift trigger of sorts — when the target percentage that a particular asset class drifts more than five percentage points in either direction, it triggers a rebalancing.

Anspach said rebalancing too frequently can mean missing out on momentum, which is basically when similar investments' values are trending higher in lockstep. "If I rebalance every quarter, I'm eliminating some of those asset classes before their run-up is over," Anspach said.

For long-term investors, Anspach advises rebalancing no more than once a year. She added, however, that if you are a very conservative investor, rebalancing more frequently or having a more smaller drift trigger could make sense.

One drawback of rebalancing too frequently is the potential for trading fees cutting into earnings.

"If you rebalance too often and there are transaction fees, you could be shooting yourself in the foot," said Moskowitz of Transformative Wealth Management. "The gain you could have [reaped] might be canceled out by transaction fees."

Another potential expense that comes with rebalancing is taxes. In a taxable account, when you sell investments at a profit, you pay taxes on those capital gains.

"If you rebalance too often and there are transaction fees, you could be shooting yourself in the foot." -Allan Moskowitz, principal of Transformative Wealth Management

Inside 401(k) plans individual retirement accounts (including Roth versions of both), taxes are deferred on capital gains until you make withdrawals.

Advisors say the most important thing is to have a rebalancing strategy and stick to it. Part of doing that goes back to accurately evaluating your risk tolerance when you set up your portfolio.

Gajkowski of Money Managers Financial Group said if people misjudge their own risk tolerance and get burned a couple times in the market, they might get out and never get back in.

"For those people, if they can narrow the band of ups and downs in their portfolio, it keeps them in the market longer," Gajkowski said. "That's the real strength of rebalancing."

— By Sarah O'Brien, special to CNBC.com

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