What is Re-Balancing?

Re-balancing, as it pertains to your investment portfolios, is the process by which we periodically “update” the allocation of your various investments so that they maintain your desired risk profile.

In English, this means that if you originally wanted to have 60% in stocks and 40% in bonds, and then the stock market went up so that your actual percentage is now 70% in stocks and 30% in bonds, we would sell the 10% of the equities and buy 10% more bonds to put the portfolio back into the 60/40 balance.

How often is this done, and what are the pros and cons?

Is Re-Balancing a Good Thing?

As mentioned, it has the positive effect of keeping your risk level (stocks are considered to be a higher risk than bonds) where you are comfortable. However, there are obvious financial considerations when you re-balance, such as:

• When you sell the asset that has increased in value, you then have a realized capital gain. In a qualified retirement account this is not important as gains are not reported; but in any non-retirement account you will have to report the capital gains when you file your taxes. One solution to this is to take enough losses (if you have them) to offset the capital gains in the same tax year. EACH YEAR WE EVALUATE GAINS AND LOSSES IN OUR CLIENT’S PORTFOLIO WITH US, AND WE DO THE AVAILABLE AND NECESSARY TAX LOSS SALES FOR THEM AND WITH THEIR PERMISSION.
   
• Many times you may be reluctant to sell out of an asset that has been doing well. Of course, there is an opportunity risk that you will not benefit from the additional gains to come; but you are also locking in the gains you take when you sell and you will maintain your risk limits.

How Often Should I Re-Balance?

Most firms do their automatic re-balancing on a quarterly basis. Clearly, the more often that you re-balance the more likely that you will have capital gains at the end of the year (if you don’t have the tax-loss selling mentioned above), since you are taking gains more frequently. Annual re-balancing is another option that some people like because it allows for you to take your gains or losses early in the year and then have the remainder of the year to adjust for tax management.

If you never re-balance then of course you don’t have capital gains to deal with; but you also are taking a chance that the portfolio will have a level of risk with which you may not be comfortable.

There is no one answer that is always correct, and it really depends on your own situation.

by Ronald Donato, Jr., CFP®, MBA
Director of Financial Services