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What Is Rebalancing?

When we speak of rebalancing in the investment world, we are referring to balancing your investment allocations back to where you started. For example, if I invested $100 and I wanted to be $50 in stocks and $50 in bonds, I would invest the money and make the trades accordingly. My 50% stock allocation and 50% bond allocation changes every day because the market moves every day and prices of these assets change along with the market. Essentially, my 50/50 allocation is set only on the day that I invest.

When Should You Rebalance?

It is good practice to look at your investment portfolio once per year and rebalance back to your original targets. The idea behind this is that you are taking some of your gains in the assets that are over your target and reinvesting those gains into the assets that have declined below your target.

A study by Gobind Daryanani titled “Opportunistic Rebalancing” suggests using thresholds as a rebalancing approach. For instance, you put a 20% threshold on each holding and monitor when those holdings hit the threshold, then rebalance. This is difficult to do without rebalancing software but can be done manually if necessary.

Another thing to be mindful of is trading costs. Don’t spend all of your returns on trading costs trying to keep your target allocations in line either.

The Bottom Line

Your investment allocation changes the day after you set it and needs to be monitored. It is ok for your allocations to change, that is going to happen and that is the reason you are investing in the first place. Just be mindful and make sure you take some of the profits off the table and stick to an investment strategy that you are comfortable with.

Financial Journey LLC is a registered investment advisor offering advisory services in the state of Virginia and in other jurisdictions where exempted. Information provided is for educational purposes only and not, in any way, to be considered investment or tax advice.

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