How Rebalancing Helps Keep Your Portfolio on Track

Revisiting your allocation helps keep your financial plan aligned with your goals, risk tolerance and time horizon.

When your portfolio is first constructed, it will ideally reflect your investment objective – a combination of your goals, risk tolerance and time horizon. Unless something changes, your portfolio should continue to align with those objectives. That’s where rebalancing plays a key role.

Rebalancing basics

The investments in your portfolio generally grow at different rates. Typically, more volatile, or risky, asset classes come with higher returns, which means those asset classes may grow at a faster rate than less volatile asset classes. As those more volatile assets grow, they begin to take up a larger percentage of your portfolio than they originally did – meaning your portfolio’s overall risk may now be higher than you originally intended. Rebalancing is the practice of bringing your portfolio back to its original asset mix, or allocation, to restore the appropriate risk level.

There are various approaches to rebalancing, ranging from making no changes to setting very specific volatility-based limits around the different asset classes in your portfolio. Choosing a rebalancing approach calls for careful deliberation, and you should consider the impact it will have on maintaining your portfolio’s intended risk and return characteristics.

Different approaches

Buy and hold is the simplest approach. Once your assets are invested, no changes are made, and the assets are free to move with the markets. The assets with the highest returns (which are likely those with the highest risk) will grow the most, which can increase the risk of your overall portfolio.

With a time-based or constant mix approach, asset class proportions are brought back in line at regular intervals, such as monthly, quarterly or – mostly commonly – annually. Bear in mind that choosing to rebalance more frequently can mean more transaction costs, paying taxes on short-term capital gains and a potential loss of returns if an asset class is not given sufficient time to meaningfully appreciate.

A drift-based or contingent approach sets a threshold, also known as a tolerance band, around each of the asset classes in your portfolio and rebalances whenever a threshold is breached. Bands can be relative or absolute. For example, setting a 10% relative band around a 40% allocation would trigger a rebalance at 44% or 36%, while a 10% absolute band would allow the allocation to drift up to 50% or down to 30% before rebalancing.

Considerations for your rebalancing strategy

In addition to costs associated with monitoring and trading, there are other factors you should consider when evaluating rebalancing approaches.

Asset class volatility: More volatile, or riskier, asset classes will breach tolerance bands in either direction much more often than less volatile asset classes. As a result, it may be more efficient to set a wider band around more volatile asset classes, unless you prefer the more frequent rebalancing.

Asset class weighting: With absolute bands, asset classes with small allocations must increase significantly to trigger a rebalancing event. Relative bands self-adjust based on the weighting of the asset, which many consider an efficiency advantage.

Other considerations: Tax implications, market conditions and the objective of the portfolio are examples of important factors to consider when rebalancing.

Rebalancing your portfolio is key to helping maintain an appropriate level of risk. Talk with your advisor about the different approaches – he or she can help you determine which method best suits your unique financial plan.

Raymond James Corporate
Privacy Notice │ BrokerCheck®

Financial Advisors offer securities through Raymond James Financial Services, Inc. Member FINRA/SIPC and securities are not insured by credit union insurance, the NCUA or any other government agency, are not deposits or obligations of the credit union, are not guaranteed by the credit union, and are subject to risks, including the possible loss of principal. First Tech Federal Credit Union and Addison Avenue Investment Services are not registered broker/dealers and are independent of Raymond James Financial Services. Investment advisory services offered through Raymond James Financial Services Advisors, Inc.

Raymond James Financial Advisors may only conduct business with residents of the states and/or jurisdictions for which they are properly registered. Therefore, a response to a request for information may be delayed. Please note that not all of the investments and services mentioned are available in every state. Investors outside of the United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Contact your local Raymond James office for information and availability.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.

There is no assurance any investment strategy will be successful. Past performance may not be indicative of future results. The process of rebalancing may result in tax consequences.