You’ve invested the money in your retirement accounts or brokerage account. Congrats! Now what? Once your money is invested according to your desired asset allocation, which is your mix of cash, bonds and stocks, it’s important to check in every six to twelve months to make sure your allocation is still intact. If your allocation has shifted, the act of getting it back on track is called rebalancing.
To begin with, your asset allocation should reflect your investment personality as well as your timeline for using the funds. For example, you can afford to have a portfolio that is a lot more risky, if you don’t need to access the money until retirement. If you are using the money for a vacation in the next couple of years, you would want to invest your funds more conservatively as a dip in the market would completely ruin your vacation plans! On the other hand, if the money is being invested for retirement you have the time and luxury to wait out drops in the market. This is why asset allocation is so important!
Once you’ve invested your funds according to your desired asset allocation, the market does what the market does and things move around. Some of your stocks, bonds or funds might dramatically increase or decrease in value and then your asset allocation percentages are all out of whack.
What exactly is rebalancing?
Rebalancing is simply the buying and selling of various funds, stocks or bonds in your portfolio to get the asset allocation back to its original desired state. I recommend checking in with your allocation every six to twelve months. While a balanced portfolio is a wonderful thing, you also want to be careful not to rebalance too often in non-retirement accounts as there are tax and fee implications of buying and selling shares too often.
Here’s how to rebalance
Let’s say you want your portfolio to be 50% stocks and 50% bonds. If the stock market does really well over the course of the year and you are now at 70% stocks and 30% bonds, you will either want to sell 20% of your stocks and invest them in bonds, or, if you have more funds available to invest, you can simply buy 20% more bonds.
The key to making rebalancing as simple as possible is to actually put numbers to it. If you have a $10,000 portfolio and want 50% invested in bonds, you would take 10,000 and multiply it by 50%. You would want to invest $5,000 in bonds. You can then rebalance to target a $5,000 dollar amount in your portfolio. You will have to recalculate this every time you rebalance as the size of your overall portfolio will most likely change and grow with time.