Why regular rebalancing makes sense

REGION – Everyone loves a winner. If an investment is successful, most people, naturally, want to stick with it. But is that the best approach?

It may sound counterintuitive, but it is possible to have too much of a good thing. Over time, the performance of different investments can shift a portfolio’s intent – and its risk profile. It’s a phenomenon sometimes referred to as “risk creep,” and it happens when a portfolio has its risk profile shift over time.

When deciding how to allocate investments, many start by taking into account their time horizon, risk tolerance, and specific goals. Next, individual investments are selected that pursue their overall objective. If all the investments selected had the same return, that balance – that allocation – would remain steady for a period of time. But if the investments have varying returns, over time the portfolio may bear little resemblance to its original allocation.

Rebalancing is the process of restoring a portfolio to its original risk profile. But remember: asset allocation is an approach to help manage investment risk. Asset allocation does not guarantee against investment loss.

There are two ways to rebalance a portfolio:

Use new money

When adding money to a portfolio, allocate these new funds to those assets or asset classes that have underperformed.

Diversification is an investment principle designed to manage risk. For example, if one investment fell from 40% of a portfolio to 30%, consider purchasing more of that investment to return the portfolio to its original 40% allocation. However, diversification does not guarantee against a loss.

Rebalancing

To rebalance is to sell enough of the “winners” to buy more underperforming assets. Ironically, this type of rebalancing actually forces you to buy low and sell high.

Keep in mind, however, that rebalancing by selling “winners” may result in a taxable event. The information in this material is not intended as tax advice, and may not be used for the purpose of avoiding any federal tax penalties. Ideally, you would want to consult with an advisor who understands both investment and tax issues before rebalancing.

Periodically rebalancing your portfolio to match your desired risk tolerance is a sound practice, regardless of the market conditions. One approach is to set a specific time each year to schedule an appointment to review your portfolio and determine if adjustments are appropriate.

  Written by Kevin Theissen, HWC Financial in Ludlow, Investment, Financial Planning, and Tax Consulting

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