3 Reasons to Rebalance
Written by: Allie Schmidt, Financial Advisor, CFP®, CPA
Happy New Year! Here at HD Wealth Strategies, we said thank you to 2019 for the stock market gains by doing an investment rebalance to start the year, as I’m sure a number of you noticed in the form of trade confirmations in your inbox. We thought this was a great opportunity to discuss why we believe rebalancing portfolios is incredibly important.
How it all begins…When we first sit down with clients to develop an investment portfolio, we discuss first and foremost financial goals for the investment, then put together a portfolio based on those goals and in line with your Personal Investment Policy. The end result is what we see as an ideal portfolio for that specific person made up of a specific breakdown of stocks, bonds, and alternative assets.
Then off it goes and our “ideal breakdown” is likely ruined within just a couple short months. Markets move, economies change, and those investments likely do one of two things: they go up or they go down. So periodically it’s important to go back in and rebalance or reset the overall portfolio to where we initially intended it to be.
We do this for 3 main reasons.
1- Appropriate Risk Exposure: If you own a 60% stock and 40% bond portfolio and the stock market goes up, you could end up with a 70% stock and 30% bond portfolio (since the stocks likely grew at a faster pace than did the bonds). If this portfolio isn’t reset or rebalanced back to where is appropriate and we have a market decline—an inevitable part of investing, this portfolio would experience more downside than was initially intended. On the flip side, if the market goes down and you don’t rebalance, you might end up with too low of a stock percentage, which limits your growth opportunity when the market rallies.
2- Sell high, buy low: Sounds easy enough, but history has shown us that in reality it’s emotionally very difficult for investors to sell the assets that did well and purchase into assets that haven’t done as well over a certain time period. But, a rebalance is doing exactly that, it’s trimming your positions that have grown faster than their counterparts. This will ensure we don’t put too many eggs in one basket and continue to have the appropriate diversification across all asset classes.
3- Tax Efficiency: This is only applicable in non-retirement accounts; however, it is incredibly important. Retirement accounts are tax-deferred so we’re able to rebalance at any time without any tax consequence to investors. Non-retirement accounts, on the other hand, are not, and are taxable any time a change is made. You can take advantage of this tax structure by realizing tax losses when they’re available to help offset taxable gains. I know, no one likes to pay taxes; however, it is a part of investing in non-retirement accounts and we’d rather see investors trim their gains, make necessary investment changes, and remain in an appropriate portfolio. This will likely require capital gain taxes to be paid from time to time to make sure we can accomplish this. Remember, you’re only paying taxes when you’re making money. We will do everything we can in an effort to minimize tax for our clients, but won’t sacrifice future growth or appropriate risk exposure because we feel that will cost our clients far more in the long run.
In the end, rebalancing is an important piece of managing long-term investment portfolios and this was a really long winded way to say…we are taking care of it.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through HD Wealth Strategies, a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directlyThe economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs. Rebalancing and diversification does not assure a profit or protect against a loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.
