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The financial market is constantly moving all the time and your investments should evolve with the changes. By reviewing and rebalancing regularly, at least annually, you can help ensure your investments are allocated in a way that is consistent with your risk tolerance. Here are 4 steps to consider.
As you begin to anticipate 2024 year-end statements, it will be tempting to focus on how well the markets performed. But especially because of this year’s solid market performance, it would be a safe bet that many investors need to consider rebalancing, because they might now be overweight or underweight certain asset classes – and therefore positioned in a way that is inconsistent with their risk tolerance and goals.
The reality is that the market moves all the time and your investments should evolve with the changes. It is important to rebalance your investments regularly, at least on an annual basis.
In simple terms, rebalancing is the process of reviewing and then possibly changing your current mix of investments in your investment accounts. For example, as you settle into your career and still have decades until your retirement, you might decide that your risk tolerance can increase, thereby allowing you to invest more in stock and less in bonds. Or your investments grow in some categories from your original allocation, and you need to get the mix back to where you started.
Without rebalancing, some components of your investment assets can become too large (or too small) a part of your total portfolio, exposing you to more risk than you can afford. Below are a few steps that can be used to evaluate whether you should rebalance.
Assemble all the information about all of your accounts. Rebalancing – sometimes referred to as reallocating – requires examining your entire portfolio.
This includes gathering statements from all your bank accounts, all retirement plans, all brokerage accounts and other investment related accounts, such as life insurance.
The key is to have a complete picture of your investment health to help ensure your investments are allocated in a way that is consistent with your risk tolerance. If you don’t know your risk tolerance number, consulting with a financial advisor would be a great way to find out.
Next, simply break down your overall positioning into four categories – cash, bonds, stocks and other (a good financial advisor can help you expand on each of these categories).
Consider bond mutual funds and individual bonds in the “bonds” category and put individual stocks and stock mutual funds in the “stocks” category. Real estate or other non-stock and non-bond investments will go into a fourth category.
Add up each category of items separately and divide that amount by the overall total. This will give you a simple look at your current ratio of how your assets are allocated.
Then discussing this ratio with a professional financial advisor, will help you decide what mix is right for you. You should know, however, that this step is a little more difficult than it sounds, because every individual is different. Sure, there are rules of thumb that can be used, but in the end, deciding on an asset allocation is a very personal decision.
The right asset allocation for you depends on factors like your age, the number of years until retirement, your income, your savings, your debt, your health, and your housing status, to name a few. And of course, applying the same factors for your spouse and considering your children, including big-ticket expenses like college education.
The point is that your asset allocation must change as time passes. Young people usually have a higher risk tolerance, while older investors facing retirement should have more conservative investments in their portfolio. So, it’s a good idea to look at your asset allocation every single year (unless you’ve figured out a way to stop aging…).
Then adjust your actual ratio to match your ideal ratio, as outlined in your financial plan. But it won’t be a matter of just trimming a little here and adding a little there – there are a lot of factors to take into account – including tax consequences – before an adjustment is made.
The good news is that a good financial advisor can run lots of different scenarios and hypotheticals with financial planning software before making real rebalancing adjustments.
Sounds painless, right? In theory, it is, but it can be a bit overwhelming the first time. But the process will be much easier next time around, especially drawing from the expertise and resources of a professional financial advisor.
