Are you out of balance?

You may hear about "portfolio rebalancing” and be told that you should do it – but you may not have any idea what it is or exactly what you should be doing. In its simplest terms, it’s exactly what you are thinking – getting your portfolio back in balance.

Portfolio balance imply refers to your asset mix. In a classic moderate risk retirement account, one might have a 60/40 mix, meaning a 60% allocation to stocks and a 40% allocation to fixed income and cash. That level is determined by your time frame to the goal and your own personal preference for risk (measured by the volatility you are willing to accept in order to try to achieve long term returns). If one wishes to accept more volatility in search of potential higher long-term returns, they could have a 90/10 portfolio, for example, or even higher. If one wants more stability and is willing to sacrifice long term returns, they’ll choose a lower stock mix.

Over time, every day actually, markets move up and down. In a positive stock market, stocks may outperform bonds. If this happens for a period of time, that 60/40 mix can become 63/37, 68/32, 75/25, etc. How far this goes depends on the extent of the move and how long you let it go. Ina down stock market it goes the other way – 60/40 can turn into 55/45, 48/53, etc., again depending on time and scale. This can happen very slowly over time, but it can also happen very quickly during market shocks.

In an up market, using the 60/40 turning into 75/25 as an example, you are earning returns, but you are taking more and more incremental risk the further it goes. Markets go up and down, so if you hit the next down time with a higher stock portfolio, you may get hit harder than you expect. Rebalancing back to the 60/40 level may allow you to take some gains, manage risk and stay within the risk profile you have chosen.

In a down market, using the 60/40 turning into 48/53 as an example, this can present opportunity. If in a down market you rebalance back to the target of 60/40, you may be taking advantage of lower pricing by adding to things that have fallen on the assumption that they will eventually recover. Of course, this is often a very difficult action to take because it’s usually when things are bleak.

By rebalancing on both sides, you can help mitigate risk on the upside and take advantage of opportunities on the downside.

Rebalancing is art as much as it is science, but it requires knowing where you are, the risk you are taking and the risk you are willing to take. A lot of people rebalance at fixed intervals, like semiannually or quarterly. Sometimes, you may prefer to rebalance less because you want to continue to let the current situation play out further. Sometimes you may want to do so more often. Again, the key is awareness of risks and discipline.

We tend to help clients rebalance regularly because we want to focus on the market environment, not time. If we see sharp gains or sharp losses outside the norm, we’ll likely want to rebalance. We can help clients make adjustments within allocations as well, adjusting weightings of individual securities as well as asset class. Of course, this assumes the securities owned still make sense within the risk profile and model for the client. By rebalancing at the security level, we can help clients take advantage of pricing and manage risk even within the larger asset class.

Again, the 60/40 is just one example, and the same principles can be applied on all risk levels. Your appropriate risk level should be based on your time frame and your situation, and you should have that conversation with your financial advisor.