During the building of my dividend based investment portfolio, I have strived to ensure that I have a well-researched and sound asset allocation. With that complete, the next step of effective portfolio management is the act of rebalancing. In this post, I am going to explain what rebalancing is and how I like to use it in my own personal portfolio.
Rebalancing is the act of boosting underweight asset classes and trimming overweight asset classes in a portfolio. It’s primary purpose is to bring your actual portfolio characteristics in line with your solid and well-researched target asset allocation. For example, let’s say that you have a target asset allocation of 40% Domestic Equity, 30% Global Equity, and 20% Fixed income. Over the course of a one year period, the markets have ebbed and flowed at times mildly and at other times dramatically. At that one year period, your portfolio asset allocation now is 20% Domestic Equity, 50% Global Equity, and 30% Fixed Income. Your actual asset allocation is now significantly off your target allocation. A careful investor would take the steps necessary to rebalance the portfolio by buying (or selling) assets to once again meet your target allocation. The reason for this rebalancing is all about managing risk.
Regardless of what asset allocation you have chosen, the primary purpose of asset allocation is to manage the risk-and-reward profile of a portfolio. A well-constructed asset allocation can effectively provide higher returns with much less risk. With a portfolio that is out-of-whack, then the investor is open to much more risk and perhaps poorer returns.
So when and how often should an investor rebalance? That entirely depends on how you elect to manage your portfolio and how comfortable you are with higher risk. If you are a very conservative investor with little tolerance for risk, then a quarterly rebalancing strategy may be an ideal strategy. If you are comfortable with more risk and like a more hands off strategy, then an annual rebalancing strategy may be best for you. One important thing to keep in mind when deciding on your strategy is to consider the tax implications of the rebalancing. If your assets are in a tax deferred account, then more frequent rebalancing is not an issue as it does not create any tax implications. However, if you have assets in a taxable account then careful consideration must be given to your portfolio actions. Taxes can eat up a big chunk of money!
My rebalancing strategy tends to be a bit more frequent, simple because I add to my investments on a monthly basis and keep my asset allocation in line by more often than not adding to positions rather than selling them. Each month I see where my asset allocation is and decide where to allocate my incoming investment money. This has allowed me to limit the selling in my account and to more frequently keep my asset allocation in line.
I would love to hear your asset allocation rebalancing strategy. Do you buy or sell dividend stocks or other assets quarterly, semi-annually, or annually? Do you rebalance at all? Let me and other readers know by using the comment section below.