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Rebalancing is a critical process for investors aiming to keep their portfolios aligned with their risk tolerance and financial goals, especially during turbulent markets. Market fluctuations can cause assets to drift from their original allocations, which may expose investors to unintended risks or hinder their long-term growth objectives. Scott Tominaga explains that by rebalancing, investors bring their portfolios back to the intended asset mix, maintaining stability and control over market exposure. Here’s a look at how and when to rebalance, along with strategies to help navigate volatility effectively.
When to Rebalance: Timing Your Adjustments
The timing of rebalancing can vary, with strategies often based on regular intervals, threshold-based rebalancing, or specific market conditions.
1. Periodic Rebalancing
Many investors choose to rebalance at regular intervals, such as quarterly, semi-annually, or annually. This approach offers a straightforward schedule, helping investors avoid the urge to react emotionally to market swings. Regular rebalancing ensures that portfolio drift is corrected at consistent points in time, preserving the intended risk profile.
2. Threshold-Based Rebalancing
With threshold-based rebalancing, investors set a tolerance range, such as 5% above or below the target allocation for each asset class. When an asset’s value moves outside of this range, the portfolio is rebalanced. This method allows for flexibility and only triggers rebalancing when significant market changes occur, ensuring that adjustments are made based on real shifts rather than minor fluctuations.
3. Market Condition-Based Rebalancing
In periods of extreme market volatility, some investors may choose to rebalance based on market conditions rather than set intervals or thresholds. This approach requires careful observation and can be advantageous during sharp downturns or rallies, helping investors capture potential gains or limit losses. However, it requires discipline to avoid frequent adjustments that may increase costs and dilute long-term returns.
How to Rebalance Effectively
Rebalancing involves selling assets that have outperformed and buying those that have underperformed to restore the target allocation. Below are key strategies to keep in mind:
1. Assessing Portfolio Performance and Risk Exposure
Before rebalancing, it’s important to review how different assets have performed and evaluate any shifts in risk exposure. For example, during a bull market, stocks may increase in value relative to bonds, resulting in a higher equity exposure than initially planned. By assessing each asset’s current value, investors gain insight into how far the portfolio has drifted from the target allocation, making it easier to determine which adjustments are needed.
2. Prioritizing Tax-Efficient Rebalancing
Selling assets to rebalance can trigger capital gains taxes, especially in taxable accounts. To minimize tax impact, investors can focus on rebalancing within tax-advantaged accounts like IRAs or 401(k)s, where trades do not incur immediate tax consequences. Additionally, using dividends and interest income to buy underweighted assets can help rebalance the portfolio without selling investments.
3. Using Cash Flows for Rebalancing
Incorporating new cash inflows—such as contributions, dividends, or interest payments—into underweighted assets is another effective way to rebalance gradually. By directing fresh funds into asset classes that have declined in value relative to others, investors can restore their allocation without incurring transaction costs or selling high-performing assets.
Benefits of Rebalancing in Turbulent Times
Rebalancing during periods of market volatility offers several benefits. First, it reinforces a disciplined approach to investing, preventing emotional decisions that can lead to “chasing” gains or selling during dips. Rebalancing also helps investors maintain their original risk tolerance, avoiding unintended exposure to market swings. Finally, it allows investors to capture gains from overperforming assets and reinvest them in undervalued areas, positioning the portfolio for potential growth as markets stabilize.
Rebalancing is an essential part of maintaining a resilient and goal-oriented portfolio, particularly during turbulent times. Scott Tominaga emphasizes that by choosing an appropriate rebalancing strategy—whether periodic, threshold-based, or market condition-based—investors can keep their portfolios aligned with their risk tolerance and financial goals. Rebalancing not only restores stability but also supports a disciplined, long-term approach to investing, helping investors stay on course through market fluctuations and build a strong foundation for future growth.
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