To achieve the right balance in your investments, it is crucial to analyse and rebalance your mutual fund portfolio at least once a year. Giving your portfolio a “health check” is the easiest way to handle risk management with your investments.
Sadly, many people overlook this simple task, and it can have serious effects on the performance and success of their portfolio.
Many people overlook rebalancing their portfolio each year because they are either unaware of how important this is to their investment strategies or are uncertain how they should achieve this task. You can learn how to evaluate your investments by using the following tips.
Table of Contents
- 1 Definition of rebalancing a portfolio
- 2 Why Is It Necessary To assess And Rebalance My Mutual Fund Portfolio On A Regular Basis?
- 3 How Often Should Rebalancing Take Place?
- 4 What Methods Should Be Used For Rebalancing?
- 5 What Variances Amount Should Trigger A Rebalancing Of My Investments?
- 6 What Other Factors Should Be Considered?
- 7 What If My Risk Tolerance or Portfolio Goals Have Changed Or One Fund Is performing Very Poorly?
Definition of rebalancing a portfolio
Rebalancing is the act of assessing your portfolio and reallocating investments for the best outcome.
Why Is It Necessary To assess And Rebalance My Mutual Fund Portfolio On A Regular Basis?
Monitoring and rebalancing your portfolio are the best ways to balance risk and reward from your investments. Another important aspect is also to own asset classes that are not correlated with one another.
When you rebalance your portfolio, you ensure that you are not relying heavily on just one area of your investments to generate income while other investments are underperforming. It is also a way to ensure that you are acquiring low and selling high.
Often, investors will see one of their stocks performing very well, so they continue to invest heavily in this bond, even though the cost of the shares is rapidly rising.
While this may seem to make sense, you are actually earning less for your investments than if you were investing into lower-valued funds and allowing them to grow.
When you monitor your investments, you can allow the high performers to continue to perform well and trim the investment amount a little to invest in lower-cost funds that will eventually rise. This will generate higher revenue for you in the long run.
How Often Should Rebalancing Take Place?
You should rebalance your portfolio at least once per year. However, with the volatility of the market, you may want to look at your portfolio twice per year. Setting a specific date, such as January 15 and July 15 of each year, will also allow you to create look-back points on your investments.
This information can help you make informed decisions in the future. For the very aggressive investor, you may wish to rebalance quarterly, but this may be too often because it will not allow funds to grow/decline for a long enough period to determine if you need to rebalance your investments.
What Methods Should Be Used For Rebalancing?
If you have a tax-deferred account, rebalancing is easy. You move the current investments around within your portfolio so that there are no tax consequences, then future investments will be allocated to your new investment goals.
If you have a taxable account, your best choice would be to just start investing from that point forward with your new allocations. This would help you avoid taxes on any gains that you have made.
However, if you made a substantial amount on any single fund, you may want to sell a portion of that investment and reinvest it into the underperforming fund. You may be able to direct the sale to allow you to pay long-term capital gains taxes.
If the sale is going to incur short-term gains taxes or interest taxes, it may be better to leave the assets alone for now.
What Variances Amount Should Trigger A Rebalancing Of My Investments?
In most cases, if the fund has changed by ten to 15 percent, it is time to reallocate funds to an underperforming fund.
The high-performing fund will still continue to generate revenue, but the underperforming fund will generate more income when it slowly rises because you have acquired more shares.
A quick example:
If you have an even 25 percent of your portfolio allocated to four different funds and one of those funds is performing very well, say a 20 percent increase, then you may want to drop the investments in this fund to 20 percent, and increase one of the lower funds to 30 percent.
What Other Factors Should Be Considered?
You must look at the type of investments you have when deciding if they are over or under-performing. For example, if you have 25 percent of your investments invested in short-term funds, you may not see a huge return on these funds within a year.
This does not mean that the equity is under performing. Short-term funds often do not generate high income.
On the flip side, if you have 25 percent of your fund invested in an aggressive growth fund, you may see huge returns right away. If the cost of these funds is still very good, it may be advisable to leave this investment alone.
Rebalancing is made for changing investment strategies for funds that are performing better than expected so that you can use your gains to boost your underweight funds.
What If My Risk Tolerance or Portfolio Goals Have Changed Or One Fund Is performing Very Poorly?
There are many reasons that your risk tolerances may change, you may be getting closer to retirement, or you may have a shift in income that changes the way you invest.
These are also good reasons to change the way your portfolio is allocated. When you have changes like this take place, you will adjust your investments to meet these new goals.
If you have a fund that is performing very poorly, it is only logical to replace that fund with something similar to keep your investments balanced but still performing.
Most investors forget to rebalance their portfolio on a regular basis, don’t be one of them and make sure to do it at least once a year.