When’s the Right Time to Rebalance My Portfolio?

Introduction

When it comes to investing, it’s not just about choosing the right assets it's about ensuring those assets continue to work for you as your financial goals evolve. Over time, portfolios naturally drift from their target allocations as some assets grow faster than others, making rebalancing a crucial component of long-term investment strategy. But when exactly should you rebalance? Is it based on time, performance, or something else entirely?

In this article, Keely Woods, Chartered Financial Planner dives into the best times to rebalance your portfolio, why rebalancing is essential for maintaining your investment goals, and how you can do it efficiently. Whether you’re just starting to invest or you’ve been managing your portfolio for years, understanding when and why to rebalance is crucial for staying on track.

The Importance of Rebalancing Your Portfolio

Rebalancing is the process of adjusting your portfolio to restore it to its desired asset allocation. Over time, as market conditions fluctuate, some of your investments will grow faster than others, shifting the balance and potentially increasing the risk in your portfolio. For example, if your portfolio was originally designed to be 60% stocks and 40% bonds, a strong performance in the stock market could push the stock allocation to 70%, increasing your risk exposure.

Rebalancing ensures that your portfolio maintains the correct balance between different asset classes, which helps to manage risk and stay aligned with your financial goals. Regular rebalancing also encourages a disciplined approach to investing, ensuring you’re not making knee-jerk reactions to market movements or overly relying on short-term trends.

Time-Based Rebalancing

One of the most straightforward strategies for rebalancing is to do it on a set time schedule. Time-based rebalancing involves reviewing and adjusting your portfolio at regular intervals whether that’s annually, semi-annually, or quarterly.

Annual Rebalancing

For many investors, an annual rebalance is sufficient to keep the portfolio aligned with their goals. A common strategy is to rebalance at the end of the year or the beginning of a new year, as this provides a clear point to assess the portfolio's performance and make adjustments based on current market conditions.

Semi-Annual/Quarterly Rebalancing

For those with more volatile portfolios or higher risk tolerance, more frequent rebalancing might be necessary. If your portfolio contains more growth-oriented assets or you’re nearing a financial milestone, such as retirement, you might prefer to review and rebalance more frequently either semi-annually or quarterly.

Read our blog - Top 10 Things to Do During Your Mid-Year Investment Review

No Need to Rebalance Too Frequently

However, it’s important to note that rebalancing too often can be counterproductive. Research from Vanguard suggests that frequent rebalancing such as monthly or quarterly does not necessarily lead to better long-term returns and can increase transaction costs. While rebalancing is important, overdoing it can result in unnecessary fees and taxes, particularly in taxable accounts.

Threshold-Based Rebalancing

Another approach to rebalancing is based on the deviation of your asset allocation from its target. This method allows for more flexibility and responds to changes in the market without being constrained to a rigid time schedule.

Percentage Thresholds

You can set specific limits for how far an asset class can deviate from its target allocation before triggering rebalancing. For example, you may decide that if your stock allocation exceeds its target by 5% or more, it’s time to rebalance.

Example

Let’s say your target allocation for stocks is 60%, but over time, the value of your stocks rises to 66%, a 10% increase. In this case, you would sell some of the stocks and buy bonds or other assets to bring the portfolio back in line with your target allocation.

This approach allows you to react to changes in market conditions while keeping your portfolio aligned with your overall financial strategy.

"The key to maintaining a portfolio that remains aligned with your goals is regular review and rebalancing. A portfolio is not a ‘set and forget’ investment market conditions change, and so should your strategy."

Luke James, Chartered Financial Planner

Event-Driven Rebalancing

In addition to time-based and threshold-based rebalancing, there are significant life events or market shifts that may warrant a portfolio review and rebalancing.

Life Events

Major life events, such as marriage, the birth of a child, or receiving an inheritance, can all trigger the need for a portfolio review. These events often bring new financial goals, changes in risk tolerance, or shifts in your investment horizon.

Changes in Risk Tolerance or Goals

If your financial goals or risk tolerance change perhaps you’re nearing retirement and want to shift to lower-risk investments rebalancing becomes essential to reflect these adjustments. You may want to reduce your exposure to high-risk assets like stocks and increase your allocation to more stable investments like bonds if you are planning on purchasing an annuity.  

Market Volatility

Significant market downturns or upturns can cause your portfolio’s allocation to drift. If the market experiences a sudden dip, your asset allocation may be out of alignment, with your equities taking a hit and bonds potentially becoming a larger portion of the portfolio. Rebalancing helps restore the desired risk profile, ensuring your portfolio remains consistent with your long-term goals.  

Read our blog - How to Ensure Investment Portfolios Remain Aligned with Goals

Key Considerations When Rebalancing

Rebalancing is more than just a mechanical process it’s essential to consider a few practical factors before making adjustments.

Minimising Transaction Costs

Rebalancing often involves buying and selling assets, which can incur transaction fees. In taxable accounts, selling assets can also trigger capital gains tax. Therefore, it’s important to factor in these costs when deciding how frequently to rebalance. Minimising transaction costs is especially crucial in taxable accounts to avoid eroding your returns unnecessarily.

Tax Implications

If you’re rebalancing in a taxable account, consider the tax implications of selling assets. Selling investments that have appreciated in value may result in capital gains tax. You can reduce this impact by rebalancing within tax-advantaged accounts like ISAs or pensions, where taxes are deferred or exempt.

Long-Term Perspective

It’s important to remember that rebalancing is not about reacting to short-term market movements. Rebalancing is part of a long-term investment strategy to maintain the risk profile and asset allocation that aligns with your goals. Don’t get caught up in trying to time the market rebalancing should be a thoughtful, planned process.

How to Rebalance Your Portfolio: A Step-by-Step Guide

Rebalancing doesn’t have to be complicated. Here’s a simple guide to help you through the process:

1. Assess Your Current Asset Allocation: Start by reviewing your current portfolio and the performance of each asset class.
2. Compare with Your Target Allocation: Check if your portfolio still aligns with your risk tolerance and financial goals. Are you overweight in stocks or bonds? Is your portfolio more aggressive than you originally intended?
3. Rebalance Based on Time, Threshold, or Events: Choose a rebalancing strategy whether time-based, threshold-based, or event-driven. Decide if you need to make adjustments based on a schedule or recent changes in the market or your personal life.
4. Make the Necessary Adjustments: Sell assets that have grown too large and purchase underperforming assets to restore balance. Remember to factor in transaction costs and taxes.
5. Review and Monitor: After rebalancing, continue to monitor your portfolio’s performance and review it periodically to ensure it remains aligned with your goals.

When Should You Seek Professional Advice?

If your portfolio is large, complex, or contains a mix of asset types (e.g., real estate, international investments), seeking professional advice can be invaluable. A financial advisor can help you determine the right time to rebalance, advise on tax-efficient strategies, and ensure that your portfolio remains aligned with your financial objectives. They can also provide guidance during significant life events or market shifts, ensuring your strategy remains on track.

Summary

Rebalancing your investment portfolio is essential for maintaining alignment with your financial goals and risk tolerance. By regularly reviewing your portfolio whether on a time-based schedule, based on specific thresholds, or in response to life events you can ensure that your investments continue to work in your favour.

While rebalancing doesn’t need to be done constantly, making thoughtful adjustments when necessary, will help you stay on track and avoid unnecessary risks. Consider the costs, tax implications, and your long-term goals when rebalancing, and seek professional advice if needed to ensure your strategy remains sound.

If you’d like to discuss strategies for effective rebalancing, our team is here to help. Get in touch for guidance tailored to your unique financial situation.

Disclaimer: This article does not constitute financial advice. We recommend that you speak to a qualified financial planner for advice tailored to your individual circumstances and goals. Financial markets may go up or down, and you are not guaranteed a return on your investment. Past performance is not necessarily a guide to future performance.