Adjusting Your Investment Portfolio: Strategies For Success

Adjusting your investment portfolio, or rebalancing, is a necessary and simple process that helps manage risk and maintain the right balance between risk and reward. Over time, a portfolio can become lopsided as the value of investments changes, and your risk tolerance shifts. The primary methods for rebalancing are selling off high-performing investments and redirecting returns, or pumping funds into underperforming asset classes. The right strategy depends on your financial situation, goals, and risk tolerance. It's recommended to rebalance annually, or when a single asset shifts more than 5%, to prevent your portfolio from drifting too far from your original allocation plan and increasing your exposure to risk.

Diversify your portfolio across asset classes, company size, geographic locations, industries and investing styles

Diversifying your portfolio is a crucial step in reducing risk and enhancing returns. Here are some detailed strategies to diversify across asset classes, company size, geographic locations, industries, and investing styles:

Asset Classes

The three primary asset classes are stocks, bonds, and cash or cash equivalents. Diversification across these classes is essential to balance risk and returns. Stocks offer high long-term gains but are volatile, especially in a cooling economy. Bonds provide stable income with modest returns but may underperform during economic expansions. Cash and cash equivalents have low risk and return profiles.

Company Size

Diversifying based on company size, or market capitalization, is another strategy. Larger companies are generally more stable and resilient during downturns, but they may offer less growth potential than smaller firms. Diversifying across a range of company sizes can help balance these factors.

Geographic Locations

Geographic diversification involves investing in securities from different countries and regions. This strategy reduces the risk of excessive concentration in one market and can provide exposure to emerging economies with higher growth potential. However, it also carries risks like currency fluctuations and political instability.

Industries

Diversifying across industries is crucial. Intermingling companies from various sectors, such as consumer discretionary, financials, and healthcare, can reduce market risk. Some industries are more sensitive to economic cycles, while others are defensive and less impacted by economic fluctuations.

Investing Styles

There are two main investing styles: growth and value. Growth stocks are typically expensive but offer high future growth potential. Value stocks, on the other hand, are considered underpriced or undervalued. Diversifying across these styles can provide a balance between higher growth potential and more affordable investment options.

Remember, diversification is a highly personalized strategy, and the right mix will depend on your risk tolerance, investment goals, and time horizon.

Use tax-loss harvesting strategies to mitigate taxes

Tax-loss harvesting is a strategy that can be used to mitigate taxes when adjusting an investment portfolio. It involves selling securities at a loss to offset capital gains and, thus, reduce the amount of tax owed. This strategy is particularly useful for investors with large, frequent capital gains and those in higher tax brackets.

• Timing: Tax-loss harvesting should be done before the end of the calendar year (December 31) as it cannot be carried forward to the next tax year.
• Taxable accounts: This strategy only applies to investments held in taxable accounts, such as stocks, bonds, or exchange-traded funds. Investments in tax-sheltered accounts like 401(k)s or IRAs are not taxed, so there is no need to minimise gains in these accounts.
• Wash-sale rule: Be mindful of the IRS wash-sale rule, which prohibits buying an identical or "substantially identical" security within 30 days before or after selling an investment at a loss. Violating this rule will result in the loss being disallowed by the IRS.
• Capital loss deduction: If your capital losses exceed your capital gains for the year, you can deduct up to $3,000 ($1,500 if married filing separately) from your taxable income. Any remaining losses can be carried forward to future years.
• Tax brackets: Tax-loss harvesting is most beneficial for those in higher tax brackets as it lowers their tax bill. If you are in a lower tax bracket, you may want to wait to use this strategy until you are in a higher bracket to maximise savings.
• Investment type: Tax-loss harvesting is most useful for investors dealing with individual stocks, actively managed funds, or exchange-traded funds. Index fund investors may find it challenging to employ this strategy.
• Long-term vs. short-term gains: The taxes you pay depend on the length of time you've owned the investment. Long-term capital gains (held for over a year) are typically taxed at a lower rate than short-term capital gains (held for a year or less).
• Opportunity cost: Consider the opportunity cost of selling an investment at a loss, especially if you believe it has the potential to recover. You may miss out on potential gains if you have to wait 30 days before repurchasing the same investment.

Rebalance your portfolio annually

Rebalancing your portfolio is about buying and selling assets to maintain your desired level of investment risk. It is necessary to ensure your portfolio stays on track to meet your financial goals and can also enhance your portfolio's returns.

When you start investing, you choose an asset allocation strategy that balances the potential for high returns with your risk tolerance. For example, you might opt for an allocation of 80% stocks and 20% bonds. However, over time, the value of the assets in your portfolio will change, causing your chosen allocation to drift.

Rebalancing involves buying and selling assets to return your portfolio to its planned asset allocation. For example, if your portfolio drifted to 85% stocks and 15% bonds, you would sell 5% of your stock holdings and use the proceeds to buy bonds.

There are two key reasons to rebalance your portfolio: risk management and improved returns.

Firstly, without rebalancing, portfolios can drift away from bonds and into more stock investments, adding significant risk. Secondly, rebalancing can enhance your returns when you rebalance between two or more asset classes with similar long-term expected returns. This allows you to sell high and buy low.

There is no hard-and-fast rule, but many investors rebalance annually, quarterly, or even monthly. Some only rebalance when an asset allocation exceeds a certain threshold, such as 5%. Research from Vanguard suggests there is no optimal rebalancing strategy in terms of portfolio returns. However, checking your investments too frequently may lead to emotional decisions.

Costs and taxes

For the DIY investor, rebalancing can be done at low or no cost, and automated investing through robo-advisors can make the process simple. However, working with a financial advisor may be more costly.

If you need to sell assets to rebalance, consider any tax implications. Rebalancing in a taxable brokerage account will trigger capital gains taxes, but rebalancing in a tax-advantaged retirement account, such as an IRA or 401(k), will not. To minimise tax liabilities, you can also use new cash contributions to purchase assets and bring your allocation into balance, rather than selling.

Consider your age when deciding on an investment ratio between stocks and bonds

When it comes to planning for retirement, it's important to know how to adjust your investment portfolio to achieve your goals. Your age is a primary consideration when managing allocation because the older you are, the less investment risk you can afford to take. As you get closer to retirement age, your risk tolerance decreases, and you can't afford any dramatic changes in the stock market.

• If you're younger than 50 and saving for retirement, you can consider investing heavily in stocks. You have plenty of time until retirement, so you can ride out any short-term market fluctuations. During this stage, you may want to focus primarily on the growth potential of stocks in your retirement savings.
• As you reach your 50s, start considering allocating a larger portion of your portfolio to bonds. A common guideline is to subtract your age from 100 or 110 to determine the percentage of stocks to hold. For example, if you're 50 years old, the Rule of 100 advises holding 50% of your portfolio in stocks, while the Rule of 110 suggests 60%. Adjust these numbers based on your risk tolerance—if you're more risk-averse, decrease the stock percentage and increase bonds.
• Once you're retired, you may prefer a more conservative allocation, such as a 50/50 split between stocks and bonds. Again, this can be adjusted based on your risk tolerance and overall financial situation.
• Keep in mind that market conditions can impact your investment strategy. It's essential to have a well-diversified portfolio across different asset classes, including stocks, bonds, and cash. Diversification will help protect your investments during market downturns and provide peace of mind.
• Regularly review and rebalance your portfolio as needed. Over time, market movements can shift your asset allocation away from your intended strategy. By periodically reviewing your portfolio, you can make adjustments to get back on track with your investment goals.
• Consider working with a financial professional to help you make informed decisions about your investment portfolio. They can provide guidance based on your age, risk tolerance, and financial goals.

Seek advice from a financial professional

Seeking advice from a financial professional can be a great way to get expert guidance on adjusting your investment portfolio. Here are some detailed instructions on how to go about this process:

Step 1: Identify Your Financial Needs

Before consulting a financial advisor, it's important to assess your financial needs and goals. Do you need help with investment strategies, debt management, budgeting, tax planning, retirement planning, or estate planning? Identifying your specific needs will help you find an advisor who is well-suited to support you in those areas.

Step 2: Choose the Right Type of Financial Advisor

Financial advisors come in different forms, including investment advisors, brokers, financial planners, financial coaches, and portfolio managers. When selecting an advisor, look for credentials such as Certified Financial Planner (CFP) or Registered Investment Advisor (RIA), as these designations indicate a higher level of expertise and a fiduciary duty to act in your best interest.

Step 3: Consider Their Service Type and Cost

Financial advisors offer a range of services, from online robo-advisors to traditional in-person planners. Online robo-advisors are typically more affordable and suitable for basic investment guidance, while online financial planning services provide more comprehensive advice and access to human advisors. Traditional financial advisors are usually the most expensive option and offer in-depth, personalized advice. Consider your budget and the level of service you require.

Step 4: Vet the Financial Advisor's Background

It's crucial to research the background of any financial advisor you consider working with. Verify their credentials, check for any disciplinary issues, and review their Form ADV and employment record on FINRA's BrokerCheck website. Ensure they have the necessary licenses and expertise to provide the services you need.

Step 5: Interview and Hire the Financial Advisor

Once you've found a potential advisor who meets your criteria, schedule a consultation to discuss your financial situation and goals. Ask questions about their experience, services, fees, and investment strategies. If you're satisfied with their responses and feel they are a good fit, proceed with the hiring process, which typically includes signing legal documents and providing financial information.

Remember, a good financial advisor should educate and empower you to make informed financial decisions. They should also be responsive, willing to explain financial concepts, and always act in your best interest.

Frequently asked questions