What is portfolio rebalancing, and do I really need to do it?
What is portfolio rebalancing, and do I really need to do it?
It’s natural to check in on your investments over time, whether markets are rising, falling or holding steady. But even when things feel calm, your portfolio can drift from its original plan. Over time, certain investments may grow faster than others, shifting your overall mix and potentially exposing you to more risk than you intended.
That’s why many investors use a process called “rebalancing” to keep their portfolios aligned with their goals.
Here’s what you need to know about rebalancing and why it matters.
What is portfolio rebalancing?
Portfolio rebalancing is about returning your asset mix back to your original plan. A well-constructed portfolio typically includes different asset classes, like stocks and bonds. Many investors use a mix of 60% equities and 40% fixed income as a starting point and then adjust those weightings according to their goals and risk tolerance.
These asset classes tend to react differently to the same market conditions, so that when one falls, the other may hold steady, or rise, to offset any losses. These market movements can cause the value of your assets to change over time, potentially giving you a greater share of stocks or bonds compared with your original target asset mix. You might then find yourself taking on more – or less – risk than you intended.
Say you start with a 60/40 portfolio of stocks and bonds, but then stock prices jump, while your bonds stay flat. Suddenly, you might find your stock holdings now represent 70% of your portfolio, versus the 60% you planned for. Although your investments may be performing well, this investment mix could cause your portfolio to be riskier than desired. To manage your risk, you may want to find ways to return to your 60/40 mix, either by selling some stocks (your outperforming assets) and buying more bonds (your underperforming assets) or embracing funds that will do this for you.
You may also want to look at the investments within each asset class through the same lens. After a big upswing, you could find yourself holding a larger proportion of assets in, say, tech stocks than you may be comfortable with. As a diversified investor, you may not want one sector, geography or asset type to have a disproportionate impact on your performance.
Why does it matter?
Ensures that portfolio matches your risk tolerance – Stocks tend to be riskier than bonds, which is why your investment plan usually includes a specific target allocation you don’t want to stray too far from. If that balance drifts – from 60/40 to 70/30, for example – you may end up exposed to more risk than you intended. If left unchecked, and equity markets suddenly drop, that higher allocation to stocks could result in even greater volatility.
Helps avoid emotional decisions – Keeping emotions out of investing is easier said than done. When an investment is performing well, it’s natural to want to funnel more money into it. Likewise, you might consider pulling money away from assets that are underperforming. This type of performance chasing, however, can cause you to buy high and sell low, which can ultimately result in a losing strategy. Rebalancing on a fixed schedule helps investors resist the urge to make impulsive choices based on recent market performance.
Keeps long-term goals in focus – News headlines and social media can draw attention to what may otherwise be normal short-term market swings, resulting in rash decision-making. Rebalancing a few times a year rather than in the midst of the ebbs and flows of the market helps cut through the noise. It’s a regular check-in with yourself and your long-term goals.
Why rebalancing is hard to stick with on your own
Requires regular check-ins, math and decisive action – Rebalancing isn’t a one-off job. It requires monitoring your portfolio’s performance and checking whether your current mix of assets has drifted from your target allocation, often by calculating how far each asset class has moved from its original percentage. You don't need to check your account daily, but a quarterly or semi-annual review helps ensure your mix stays aligned with your goals. Still, it takes greater discipline, especially if you’re managing individual investments within your portfolio.
Second-guessing – It can feel counterintuitive, because it often means selling what's gone up and buying what hasn’t. But the goal of portfolio rebalancing is to manage your risk, rather than focus solely on profits and loss. Having a plan will help you follow through on selling your winners to keep your risk in check.
Controlling your emotions – In volatile markets, the most common mistakes investors make are panic selling, holding onto cash and dropping their commitments to portfolio rebalancing. When downturns happen, stock values typically drop, while bonds might hold steady or even increase in value. Investors, in turn, may fear making any sudden changes to their investments. On the other hand, investors could miss out on buying into underperforming areas, which can help them get back on track with rebalancing their portfolio.
How managed portfolios solve for this
Managed portfolios take the guesswork out of rebalancing by doing it for you.
Many investors find rebalancing stressful or easy to forget. That’s why some investment products rebalance for you. For instance, Fidelity Managed Portfolios or Fidelity All-in-One ETFs are overseen by professional managers who monitor performance and adjust the mix as needed. It also helps to work with an advisor who can stay on top of your portfolio for you and rebalance on your behalf.
Ultimately, rebalancing can help you make sure you’re taking on the amount of risk you need to meet your long-term goals.
