Rebalancing Your Investment Portfolio: How Often Is Necessary?

How often you should rebalance your investment portfolio depends on your individual circumstances and goals. Generally, investors can rebalance their portfolios as often or as little as they like. Some investors prefer to rebalance at set time points, such as monthly, quarterly, or annually. Others rebalance at set allocation points when the weights of assets in a portfolio change by a certain amount. For example, Vanguard recommends investors implement an annual rebalance, but this is by no means a rule. Ultimately, the key is to pick a schedule that's easy to follow and stick with it.

How often to rebalance: monthly, quarterly, or annually

There is no one-size-fits-all answer to how often you should rebalance your investment portfolio. The frequency of rebalancing depends on various factors, including your investment goals, risk tolerance, and personal preferences. However, some common approaches to determining the rebalancing schedule are:

Monthly, Quarterly, or Annually

A common approach to rebalancing is to set a regular schedule, such as monthly, quarterly, or annual reviews. Many investors choose to rebalance their portfolios at these intervals to maintain a disciplined approach and stay aligned with their financial goals. This method is straightforward and easy to follow. However, it may result in unnecessary transactions and costs if the portfolio has not drifted significantly from the desired asset allocation.

Trigger-based Rebalancing

Another approach is trigger-based rebalancing, where you set a threshold, such as a 5% or 10% drift from the target allocation, as a trigger to rebalance. For example, if your portfolio deviates by more than 5% from the desired mix of stocks, bonds, and other assets, you would then rebalance it. This method ensures that you only rebalance when necessary, but it requires regular monitoring of your portfolio.

Factors to Consider

When deciding on the rebalancing frequency, it's important to consider your investment goals, risk tolerance, and the stage of your investment journey. For example, those closer to retirement may want to rebalance more frequently to reduce risk. Additionally, it's essential to be mindful of the potential costs associated with rebalancing, such as transaction fees and taxes on capital gains.

Ultimately, the best rebalancing strategy is one that aligns with your financial objectives and risk appetite. It's crucial to regularly review and adjust your portfolio to ensure it reflects your current circumstances and goals.

Calendar-based rebalancing

This time-based approach makes it easier for investors to get into the habit of rebalancing. However, the downside of rebalancing at set calendar points is that investors may end up rebalancing needlessly, which can lead to unnecessary transaction costs and other investment fees.

Vanguard research found that there is no optimal rebalancing strategy. Whether a portfolio is rebalanced monthly, quarterly, or annually, portfolio returns are not significantly different. However, checking investments too frequently may lead to emotional decisions that are not in line with long-term goals.

Trigger-based rebalancing

There are two common types of trigger-based rebalancing: allocation triggers and hybrid triggers. Allocation triggers set boundaries on asset allocations, forcing a portfolio to be rebalanced when a boundary is violated. For example, a 5% trigger set on a 50/50 stock and bond allocation would rebalance the portfolio whenever one asset class reaches 55% or 45%. The hybrid method combines a rebalance frequency with an allocation trigger. For example, an investor may set an annual rebalance frequency with a 5% trigger, stating that the portfolio will be rebalanced at least once a year, and also if the portfolio deviates by 5% from its target during the year.

The main advantage of trigger-based rebalancing is that it allows the portfolio to shift with the market and only rebalances when there has been a significant move. This approach can help to minimise taxes and transaction costs associated with rebalancing. However, it requires regular monitoring and may result in more frequent rebalancing during volatile market periods.

When deciding on a rebalancing strategy, investors should consider their risk tolerance, investment goals, and the time they are willing to dedicate to managing their portfolio. Trigger-based rebalancing can be a good option for those who want to allow their portfolio to shift with the market while also maintaining their desired allocation.

Tax considerations

When rebalancing your investment portfolio, it is important to be aware of the tax implications of selling profitable investments. The taxes you will incur depend on the type of account you are selling from and whether your capital gains are taxed at a short- or long-term rate.

• Start with tax-advantaged accounts: Rebalancing trades in tax-advantaged accounts such as IRAs or Roth IRAs are tax-exempt at the time they are made. This avoids immediate tax consequences, which may be beneficial during periods of high income.
• Redirect cash flows in taxable accounts: Instead of selling overweighted assets, you can direct new purchases and reinvested distributions into underweighted asset classes. For example, if your portfolio target allocation is 50% stocks and 50% bonds, but it has drifted beyond this threshold, you can add new contributions or reinvest dividends into the underweighted side until the portfolio is back at the target allocation.
• Consider cost basis: Look for opportunities to harvest losses or manage cost basis across holdings. In comparatively low-income years, consider selling lower-basis shares, and in comparatively high-income years, consider selling higher-basis shares. If income is stable year over year, an average accounting method may be suitable.
• Explore charitable giving and annual gifting: Consider rebalancing opportunities when deciding how and what to gift. It might make sense to gift shares of overweighted holdings with a low-cost basis in a taxable account directly to a charity or beneficiary.
• Timing of fund distributions: Be mindful of the timing of fund distributions when rebalancing near year-end. Selling before a distribution can help avoid taxes on that distribution, while buying right before a distribution may have its own tax and income implications.
• Use rebalancing to improve tax efficiency: Take advantage of rebalancing opportunities to shift the portfolio into more tax-efficient options, such as exchange-traded funds, passive investments, or other low-turnover options.

In addition, there are a few other general strategies to minimise taxes when rebalancing:

• Avoid selling profitable investments: Instead of selling, you can stop making new contributions to certain asset classes and redirect those funds to underweighted holdings over time. This strategy helps to minimise potential tax liabilities.
• Place your portfolio in a tax-advantaged account: By placing your portfolio in a tax-advantaged account such as an IRA, you can avoid taxes while rebalancing and are only liable for taxes when you start withdrawing from the account.
• Use new cash contributions: To minimise capital gains taxes, use new cash contributions to purchase assets that bring your allocation into balance. This allows you to decrease the percentage of one asset by investing more in another until balance is restored.
• Tax-loss harvesting: Take advantage of any capital losses through tax-loss harvesting to decrease the amount you may owe on capital gains. This involves selling assets at a loss to offset capital gains tax liabilities.

Retirement planning

Understanding Portfolio Rebalancing

Portfolio rebalancing is the process of realigning your investments to maintain your desired asset allocation. It ensures your portfolio stays aligned with your financial goals and risk tolerance. By rebalancing, you buy or sell assets to return to your target asset mix. For example, if your portfolio has drifted to 85% stocks and 15% bonds, you would sell a portion of your stocks and use the proceeds to buy bonds to return to your desired allocation.

Factors Influencing Rebalancing Frequency

The frequency of rebalancing depends on various factors:

• Market Volatility: In volatile markets, more frequent rebalancing may be necessary to maintain your desired asset allocation.
• Personal Risk Tolerance: If you have a low-risk tolerance, you may prefer more frequent rebalancing to stay within your comfort zone.
• Life Changes: Major life events, such as health issues or family changes, may require portfolio adjustments.
• Income and Taxes: Higher-income investors may rebalance less frequently due to the potential tax impact.
• Investment Costs: Transaction costs, including custodian and market impact fees, should be considered when determining the rebalancing frequency.

Common Rebalancing Strategies

There are two common rebalancing strategies:

• Time-Based Rebalancing: This involves rebalancing at set intervals, such as quarterly, semi-annually, or annually. It is simple to implement and helps maintain discipline in your investment strategy. However, it may lead to unnecessary transactions if the portfolio hasn't drifted significantly.
• Threshold-Based Rebalancing: This strategy triggers rebalancing when your asset allocation deviates beyond a predetermined threshold, typically 5% or 10%. It responds to market movements and actively manages risk but requires more frequent monitoring and may increase transaction costs.
• Combination Approach: This combines time-based and threshold-based approaches, rebalancing at set intervals or when thresholds are breached, whichever comes first. It balances the benefits of both strategies but requires more attention and may still result in suboptimal timing in certain market conditions.

When planning for retirement, it is essential to:

• Start Early: The earlier you start planning for retirement, the better. Generally, younger investors can allocate more to riskier investments like stocks, as they have more time to recover from losses. As you approach retirement, you may want to reduce risk by shifting towards less volatile assets like bonds.
• Monitor Regularly: Regularly monitor your portfolio, even if you don't rebalance frequently. This helps you stay informed about your investments and make timely adjustments when needed.
• Consider Tax Implications: Tax implications are a significant factor when rebalancing for retirement. Prioritize rebalancing in tax-advantaged accounts like IRAs to avoid triggering taxable events. Use new contributions to direct funds to underweighted asset classes and minimize selling.
• Seek Professional Advice: Working with a financial advisor can help optimize your rebalancing strategy and ensure it aligns with your overall retirement goals. They can provide valuable guidance on balancing income needs, tax impact, and risk management.

In conclusion, portfolio rebalancing is a crucial aspect of retirement planning, helping you maintain your desired risk level and investment strategy. The frequency of rebalancing depends on market conditions, personal risk tolerance, and life changes. By adopting a suitable rebalancing strategy and seeking professional advice when needed, you can ensure your investments support your retirement goals and long-term financial objectives.

Frequently asked questions