Why It’s Important to Rebalance Your Portfolio Each Year
Rebalancing your portfolio is something that should be done consistently—but it’s easy to forget, and skipping it can affect your long-term investment progress. At its core, rebalancing is a key strategy for keeping your asset allocation on track and so your portfolio stays healthy and aligned with your goals.
So, what does “rebalancing” really mean?
Over time, some investments may outperform others, while some may lag behind. This can shift your original allocation, meaning your portfolio no longer reflects the balance you intended.
Rebalancing involves adjusting your holdings and selling some of the investments which have grown and using the proceeds to buy more of those which have fallen behind. The result is restoring your portfolio to its target allocation.
Think of it like visiting a chiropractor to realign your spine. Your portfolio benefits from a reset too. You’re taking profits from your strongest performers and reinvesting them in areas needing a boost.
Here’s a simple example: Suppose your ideal allocation is 70% stocks and 30% bonds. If stocks rise faster than bonds, your allocation might drift to 80% stocks and 20% bonds. To rebalance, you’d sell some stocks and buy bonds to return to your 70/30 target.
It’s really this straightforward, but the bigger question is: why does it matter so much for your long-term wealth?
Rebalancing May Reduce Risk
It may be tempting to double up on your winners, but this isn’t wise. Investing 101 says to buy low and sell high. If one asset class starts to make up too much of your portfolio, it may mean you have too many eggs in one basket. If the asset class starts crashing, a sizable chunk of your portfolio could decline with it.
This goes both ways. If an asset class performs poorly and starts to make up less of your portfolio, you now have too few eggs in one basket. If you fail to rebalance and this asset class starts doing well, you won’t be in a position to take full advantage of it. In addition, purchasing more shares of lagging investments may happen at lower prices. Therefore, when those lagging investments start doing well again, your overall gains may be greater as well.
Basically, if you never rebalance your portfolio, your allocation will gradually shift so you’re no longer invested according to your risk tolerance (either too aggressive or not aggressive enough). Given enough time and the potential for greater returns from stock investments, your “balanced” portfolio may end up evolving into a riskier “growth” portfolio without realizing it.
The general recommendation is to rebalance every year. This is a good guide for most people, but in reality, rebalancing is recommended whenever the balance in an asset allocation changes by 5 percentage points.
It Allows for a Deep Inspection
Rebalancing is not only a time to balance asset allocation, but it’s also a time for balancing funds within each asset allocation.
For example, you may look at your small-cap stock fund and realize one fund has grown substantially more than the rest of your stock holdings (e.g., large-cap, mid-cap, and international). When this happens, try to fight your natural reaction to buy more of this fund. If you follow the “buy low, sell high” philosophy, you would sell some of this high-performing fund to buy more promising underperforming funds. This way, you decrease risk by not having one fund representing too much of an asset class.
Annual rebalancing may also be the time to evaluate your own time horizon and risk tolerance. During a particularly rough year where you were constantly checking your portfolio balance during a volatile market, if you admit you’re not so “risk-tolerant” as you thought, rebalancing gives you the opportunity to ratchet back your stock and volatility exposure to an allocation which may be more suited to your current level.
How Rebalancing Is Processed
Depending upon the investment company who holds or “custodies” your investment portfolio, you may have a rebalancing feature available where all that’s needed is to select “Rebalance My Portfolio” on the website and let the algorithm do the work for you.
If not, then some math may be needed. First, calculate how much each holding has gained (or lost) since the last rebalancing and how much needs to be sold (or bought) of each to bring its percentage in your account back to the original prescribed level. Then sell enough of each of the holdings with the largest gains to achieve their desired allocation percentage. Finally, take the proceeds and divide them among the remaining lagging holdings, buying enough of each to get their allocation back to the desired level, as best as possible.
Next Steps to Rebalance and Strengthen Your Portfolio
It would be nice if investing were truly “set it and forget it.” In reality, a successful portfolio requires regular attention. Over time, market movement can cause your asset allocation to drift, potentially increasing risk or pulling you off track from your long-term goals. Regular rebalancing helps your portfolio continue to reflect your objectives, time horizon, and comfort with risk.
At The Rosamond Financial Group, we have the pleasure of working with clients of different ages, backgrounds, and life stages, as well as niche groups with unique financial concerns. We believe investors deserve specialized advice and personalized attention—not a one-size-fits-all approach. By serving a focused group of clients, we’re able to dedicate more time to each relationship and tailor strategies to fit individual needs.
We apply our experience to rebalance your portfolio, monitor your investments, and help keep your overall strategy aligned as markets and life circumstances change.
If you’d like guidance or want to better understand how rebalancing fits into your broader financial plan, we invite you to book a free introductory meeting online and learn how we can help.
About Preston
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with over two decades of industry experience. He provides comprehensive wealth management and financial services to successful business owners, corporate executives, and affluent retirees who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch, a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing solutions@rosamondfinancialgroup.com or schedule a call on his online calendar.