A healthy and diversified portfolio plays a critical role in preserving your wealth as well as helping it grow for your retirement years. Throughout the year many savvy investors will make changes and play to make the most out of short, mid, and long-term market opportunities. As one quarter turns over to another and yet another, chances are your portfolio can be a little unbalanced.
Many investors find themselves looking at their portfolio in a situation like this and they notice that they are a little too heavily invested in some sectors, and not invested heavily enough in others. While this is natural, it’s also something that could put your investment capital and your long-term wealth at risk.
Rebalancing is the art and science of altering your investment portfolio for renewed diversification. It is often an overlooked step in maintaining a healthy, diversified portfolio while also being aligned and consistent with your risk tolerance.
Rebalancing is intended to realign your portfolio with your intended asset allocation. When you evaluate these factors together, you should take the time to consider and determine how conservatively you can invest, while still being able to reach or even exceed your investment goals. This includes taking measures to hedge against risk and staying invested in funds that can help to effectively insulate your wealth.
The key component of this process is to develop a clear and confident understanding or your risk tolerance. Taking on a higher level of risk than you are comfortable with can have some major consequences on the long-term strength of your portfolio. Investors who are risk averse tend to panic easily causing them to sell quickly when the market experiences some significant losses in certain sectors, only to re-enter those sectors later when prices rebound higher!
How Often Should I Rebalance My Portfolio?
Taken in a certain light, there are no hard and fast rules on when you should or shouldn’t rebalance your portfolio. Yet it also isn’t the sort of thing that you should put off for too long. There are some experienced investors and financial advisors who advocate rebalancing your portfolio once a year. There are others advocate rebalancing based on major market trends, so long as you stay within the parameters of your risk tolerance.
The rebalancing can even feel counterintuitive to some investors. Especially those who have recently seen gains after taking on an aggressive approach.
Ideally, when you rebalance, you are essentially selling positions that outperformed in a specified span of time. You can then use the proceeds from those sell-offs to purchase more of another position that did not grow as quickly.
At the same time, you don’t want to put all your eggs in one basket, or over-invest in one sector. Dividing your investment capital amongst multiple investment vehicles can be a good way to monitor the performance of various investments over time.
This provides you with the opportunity to see a broader range of market trends and evaluate the areas where you might want to make future changes. Throughout the process, you are also making an effort to maintain a healthy portfolio.
What Is The Best Strategy For Rebalancing My Portfolio?
The specific strategy that you use when rebalancing your portfolio starts with making sure that you have accurately identified your risk tolerance. This will serve as your investment bellwether for fleshing out your rebalanced investment strategy.
At the same time, you have to remember that you are intending to spread your investment portfolio across a broader range of asset classes, including things like precious metals as well as other investments such as stocks, and bonds, or perhaps real estate. This is known as Asset Allocation.
How the market performs can certainly change your risk tolerance toward various asset classes and sectors. This can potentially even shift in your long-term goals to ensure your allocation levels are on target.
Let’s say that you have taken a close look at the short and long-term performance of the precious metals market, and you have decided that you would like to rebalance with a stronger position in things like gold, silver, and platinum.
For the sake of this example that your initial allocation held 25% in various precious metals with the remaining 75% allocated in other investments of stocks, and bonds, as well as other things like real estate. For the most part, this is a relatively wise strategy for diversification.
Then through the course of the following five years, the market performance shifts to affect your portfolio, gradually moving you off your initial target allocation to say 15% in the precious metal assets with the remaining 85% in other investments. This essentially means that your portfolio has now become out of balance.
In a scenario like this, it can help ensure the health of your portfolio to redirect 10% from one or more over-performing assets into an under-performing asset, to rebalance it again. This includes the relative stability of precious metals like gold.
How Do I Factor My Time Horizon With My Risk Tolerance?
The reality for most investors is that their risk tolerance changes over time, just like your financial goals are likely to change over time. Your time horizon needs to be factored in with your long-term objectives and your risk tolerance now, as well as a few years down the road.
Many savvy investors have different goals set for each time horizon. The positions they are strong in for the short-term time horizon might be different than your long-term time horizon’s goals.
Let’s say that you have a short-term time horizon with low-risk tolerance to help you feel more secure in the here-and-now. Yet your longer time horizon may a more aggressive approach to make more significant gains as you get closer to retirement.
In a scenario like this, you might periodically rebalance your portfolio with a gradually increasing amount of gold and other precious metals, which historically hold their value. It can be a great rebalancing strategy to preserve newly acquired gains, without risking them on the more volatile stock market.