Portfolio Rebalancing: Does It Matter?
Does rebalancing your portfolio really matter?
Will portfolio rebalancing increase your rate of return, or reduce risk?
Let’s discuss.
Contents
Rebalancing: Defined
Rebalancing is process of realigning the weightings of a portfolio of assets, and this realigning requires the investor to buy or sell stocks and bonds in the portfolio to maintain a desired level of asset allocation.
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Most investors create a portfolio with a certain blend of stocks, bonds, and other investments. Stock and bonds offer a variety of investing options, depending on your risk tolerance, your need to generate income, and your desired rate of return. Assume, for example, that Jill has the following investment portfolio in her Individual Retirement Account (IRA) on September 30th:
| Investment | Dollar Amount | Percentage |
| Aggressive Growth Stock Fund | $20,000 | 20% |
| Mid-Cap Stock Fund | $25,000 | 25% |
| Large Cap Stock Fund | $25,000 | 25% |
| Corporate Bond Fund | $30,000 | 30% |
| Total | $100,000 |
The percentages invested in each category were determined with the help of her investment advisor. Jill is young, and therefore invests 70% of the portfolio in stock mutual funds, and 30% in bonds. This 70%/ 30% mix is referred the asset allocation.
She is willing to take a moderate level of risk, and you’ll note that 20% of her total portfolio is invested in an aggressive growth stock fund- the stock fund category that offers the highest risk and potential return.
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Dealing With Changes
Assume that, between September 30th and November 30th, stocks in the aggressive growth category increase by 20% in price. The mid-cap and large cap stock funds grow by 5%, and the corporate bond fund grows by 3%. Here’s how the same portfolio looks as of November 30th, assuming no additional investments or withdrawals:
| Investment | Dollar Amount | Percentage |
| Aggressive Growth Stock Fund | $24,000 | 22.3% |
| Mid-Cap Stock Fund | $26,250 | 24.4% |
| Large Cap Stock Fund | $26,250 | 24.4% |
| Corporate Bond Fund | $30,900 | 28.8% |
| Total | $107,400 |
As you can see, the percentages of asset mix have changed. The aggressive growth fund, for example, is now greater than 20% of the total portfolio, while the corporate bond fund has declined below 30%.
Rebalancing requires the investor to sell some of the aggressive growth fund and add those available dollars to the other categories.
How Mutual Funds Can Help
Fortunately, mutual fund companies and other money managers can automate this process for you. American Funds, for example, explains how you can have your mutual fund portfolio automatically rebalanced.
What If You Don’t Rebalance?
Over time, different funds (or individual stocks and bonds) will change in price at different rates. The longer you put off rebalancing, the more the asset mix in your portfolio will change.
You may end up with an asset mix that is far different than your investing goals.
Jill, for example, wants a 70% stock/ 30% bond mix. If stock prices increase greatly over 18 months, while bond prices remain flat, she may end up with an 85% stock/ 15% bond mix.
That asset mix doesn’t match Jill’s investing goals.
A Different View
Now, the Wall Street Journal has an interesting take on rebalancing. The author suggests that, once an investor reaches a specific dollar amount in a particular category, they may not choose to rebalance. If, for example, Jill wants $300,000 in her bond category by retirement, she may not add to the bond fund once she reaches that specific dollar amount.
My Take
I think all investors should rebalance each month, until the dollar amounts reach pre-determined dollar amount in the future. Once that dollar amount is reached in a particular category, it’s time for an assessment.
Have a conversation with your financial advisor, and get some objective advice before your stop the rebalancing process. If, for example, Jill keeps investing in stocks and doesn’t add in the bond category, for example, a growing percentage of her portfolio is in a riskier category- stocks.
If that really what she wants?
Food for thought.
This post is for educational purposes only.
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(website and blog) https://www.accountingaccidentally.com/
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