How to rebalance your portfolio

In this article, we will talk about why you need to rebalance your portfolio, how often you should do it and how to rebalance your portfolio for accounts that you are regularly investing in vs. accounts that you are no longer investing in.

Summary

  • Why you should rebalance your portfolio

  • How often should you rebalance your portfolio?

  • How to rebalance your portfolio

    • For accounts that you are no longer investing in

    • For accounts that you are regularly investing in

Why you should rebalance your portfolio

Because different assets change in value over time, your portfolio can drift out of your intended allocation. By rebalancing assets, you are trading value out of strong-performing assets into weaker assets, which is a form of “buy low, sell high” that boosts long-term results.

How often should you rebalance your portfolio?

You can balance your portfolio when the percentage of a certain fund has shifted more than a certain percentage or at a certain time frequency. For example, you can rebalance your portfolio:

  • when one of the fund has shifted more than 10% of its desired percentage;

  • or once a year.

If you don’t always log in to your broker and check the balance, then maybe it is easier to just set a reminder to rebalance your portfolio once a year.

How to rebalance your portfolio

While there are some brokers that give you the option to rebalance your portfolio automatically at a frequency of your choice, many other brokers don’t have such service. Here is how to manually rebalance your portfolio.

For accounts that you are no longer investing in

For an account that you are no longer putting new investment in, it is very easy to rebalance them. You can rebalance it with the following steps:

  1. Calculate the desired balance for each fund, based on the total portfolio value and the desired percentage for each fund.

  2. Sell part of the fund that has more percentage than desired, then use the money to buy the fund that needs more percentage.


Here is an example:

Let’s say if you have three holdings in your portfolio with a total value of $1,000, and you have the desired percentage of:

  • 70% of fund A

  • 20% of fund B

  • 10% of fund C


Now, the current value of the funds have the following percentage:

  • 80% of fund A ($800)

  • 5% of fund B ($50)

  • 15 % of fund C ($150)


Based on your desired percentage, you want to have:

  • $1,000*70% = $700 of fund A

  • $1,000*20% = $200 of fund B

  • $1,000*10% = $100 of fund C


In order to reach the desired percentage, you will:

  • Sell $800 - $700 = $100 of fund A

  • Sell $150 - $100 = $50 of fund C

  • Then purchase $100 + $50 = $150 of fund B


However, keep in mind that every time you sell stock at a profit, you might have to pay taxes on the gain (depending on your income, state or country of residence, etc.).


As such, a “tax optimized” form of rebalancing likely involves minimizing sales of stock that have unrealized capital gains and increasing the sale of stock that has unrealized losses. However, at some point in order to maintain your desired allocation, some kinds of capital gains have to happen.

For accounts that you are regularly investing in

For accounts that you are regularly investing in, you can use the new fund to rebalance your portfolio. This will prevent you from selling stocks, which might generate capital gains leading to taxes.


Depending on the size of your portfolio and how much money you are transferring in, you may be able to effectively rebalance your allocation entirely through new investments, which generally aren’t taxable events.


Here is an example:

Let’s say if you have three holdings in your portfolio with a total value of $1,000, and you have the desired percentage of:

  • 70% of fund A

  • 20% of fund B

  • 10% of fund C


Now, the current value of the funds have the following percentage:

  • 80% of fund A ($800)

  • 5% of fund B ($50)

  • 15 % of fund C ($150)


And every month, you are investing an additional $500. Now, with that additional $500, you will have a total of $1000 + $500 = $1500 in your portfolio.


With you desired percentage, you want to have this much amount in each fund:

  • $1,500 * 70% = $1,050 of fund A

  • $1,500 * 20% = $300 of fund A

  • $1,500 * 10% = $150 of fund A


In order to reach the desired percentage, you will:

  • Buy $1,050 - $800 = $250 of fund A

  • Buy  $300 - $50 = $250 of fund B

  • Since your desired fund C amount ($150) is the same as current holding, there is no need to buy any fund C this month.


Of course, it gets more complicated if you have more funds in your portfolio, but the above is a general idea of how you can rebalance your portfolio.


There are funds or services that are already diversified and automatically rebalance over time, check out these articles about Robo advisors and target date funds.

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