Building your wealth
Here’s why it might be a good time to rebalance your portfolio
Rebalancing your portfolio is an important part of managing your money. Rebalancing means buying and selling positions in your portfolio to get back to your original asset allocation. When one asset class significantly outperforms another, your portfolio drifts from its starting investment mix. This is important because unless you periodically rebalance, you may be taking on more risk than you expect.
There's no one way to rebalance your portfolio and the timing can vary. One way is to schedule a periodic review of your account, perhaps twice a year. Another option is to set maximum thresholds for drift. If an asset class in your portfolio exceeds the target by more than your acceptable threshold, then you may consider a rebalance.
For example, if you have a 5% threshold for drift and a target allocation of 65% equity, your investment plan may suggest rebalancing when stocks represent more than 70% of your entire portfolio or less than 60%.
As of November 29th, 2021, the S&P 500 was up around 25% for the year (including dividends). Since 2019, stocks are up 97%! If you haven't rebalanced your accounts, it's very likely you are overweight equity.
Assume at the beginning of 2020 an investor had a 50/50 portfolio split between the S&P 500 and the Bloomberg Barclays U.S. Aggregate Bonds. By November 29th 2021, their equity allocation would have a total return of 48.6% versus 5.8% for fixed income.1 As a result, the 50/50 mix has now become roughly 58% and 42% mix of stocks to bonds. That's an 8% drift.
If the investor didn't rebalance, and there was a -10% correction in the stock market (assume bonds maintain the same 5.8% return), the account would be down almost -3.4% from its previous peak.
But had the investor rebalanced to the original 50/50 asset allocation, their investments would be down -2.1%. By rebalancing, the individual reduced their losses by almost 39%.
Rebalancing may seem counterintuitive. After all, the basic premise is selling outperforming funds and buying assets that didn't do as well. But it's important to remember the role of each in your portfolio. Bonds, for example, can provide stability and income. They're not supposed to outperform equities with any regularity.
¹Indexes are unmanaged and an individual cannot invest directly in an index. Returns do not include trading costs, fees, fund expenses, or other costs that may apply when investing. Past performance is not indicative of future results. Assumes all dividends and income is reinvested. Assumes there are no other cash flows in or out.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.