Any time is a good time to considering portfolio rebalancing. That said it should probably only be done annually or when there is a significant change in your financial landscape.
With the rise of stock prices and the prospect of moderate inflation, now is a good time to see if your investments are in sync with your priorities.
What is Portfolio Rebalancing
Portfolio rebalancing is a form of financial chiropractic care. Your investments can get out of wack, just like your back. It involves comparing where your money is relative to your financial goals.
For instance, you may have had a good run in the stock market this year. That is good, but it has thrown your portfolio out of balance. More money is in stocks than in more conservative investments such as bonds. You must move more money into bonds or out of stocks to rebalance your portfolio.
Before you can begin portfolio rebalancing, you must understand asset allocation. This is the practice of putting money into various investments to achieve your financial goals.
Typically younger people will have more of their portfolio in growth and higher-risk investments. Because they have more time to let investments accumulate. Likewise, they have more time to recoup losses.
In a similar vein, older investors tend to move their portfolios into safer, more conservative investments. They do not have as much time for growth or to recover from losses.
You will have different financial goals depending on what you want in life. A person without children will have different financial objectives than a couple with children. In retirement, almost everyone wants income and financial stability.
Your goals will vary depending on how you want to live. They will also shift with age. Your portfolio should change with you.
Another factor in asset allocation is your risk tolerance.
If you lose sleep over your investments, you probably have a low-risk tolerance. More conservative investments are better for you. However, if the rise and fall of economic tides don’t bother you, a moderate to high-risk approach will work best.
How To Rebalance Your Investments
There are two methods for portfolio rebalancing. For simplicity, we will limit your portfolio to stock and bonds.
One strategy is to sell investments in one area of your portfolio and reinvest in the other. As an example, say your asset association goal is 70 percent stocks and 30 percent bonds. Suppose stocks increase to 80 percent of your portfolio. This method dictates that you sell stocks. The proceeds would then go into bonds until you restored the 70-30 balance.
Another strategy calls for investing new money to restore your portfolio balance. In this case, you do not sell stocks. You invest new money in bonds until the 70-30 balance is achieved.
Long-Term Capital Gains
Beware of capital gains taxes if you sell an investment to rebalance your portfolio.
The capital gains tax is assessed on the profit you make from the sale of an asset. It is important to know that capital gains tax is only triggered when an asset is sold. If an asset posts a gain, but you do not sell it, there is no tax.
Time is also a factor in determining capital gains taxes. To qualify for a more favorable long-term capital gains rate, an asset must be owned for more than one year.
Investments in your 401k, IRAs, and other tax-advantaged accounts are not subject to capital gains taxes.
Portfolio rebalancing is a way of making sure your investments are working to meet your financial goals. It also helps instill discipline in meeting those goals.
It is tempting to stray from your financial game plan. That is especially true In an upmarket or when your friends are bragging about how much they on a wild stock bet.
However, having a clear plan for meeting your financial goals will help you achieve them. And rebalancing your portfolio regularly is an important part of any financial plan.
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Max K. Erkiletian began writing for newspapers while still in high school. He went on to become an award-winning journalist and co-founder of the print magazine Free Bird.
He has written for a wide range of regional and national publications as well as many on-line publications. That has afforded him the opportunity to interview a variety of prominent figures from former Chairman of the Federal Reserve Bank Paul Volker to Blues musicians Muddy Waters and B. B. King.
Max lives in Springfield, MO with his wife Karen and their two cats. He spends as much time as possible with his kids, grandchildren, and great-grandchildren.
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