5 Steps to Take When Rebalancing Your Portfolio

If you want to invest effectively, you need to periodically rebalance your investment portfolio. In other words, you’ll invest your money in different proportions to different types of assets. This redistribution method allows you to diversify your portfolio, while giving you an opportunity to reevaluate the value of your current assets. To new investors, this process can be intimidating, but it’s simple if you take it one step at a time.

Why Rebalance a Portfolio?

Rebalancing a portfolio is designed to help you change your investment holdings as your goals change. Over time, your goals in the following areas may evolve:

• Risk. Most people get less tolerant of risk as they get older. When you’re young, you have plenty of time to make up for any losses you sustain in an investment—even if they’re major. Accordingly, you want to go for more high-risk high-reward plays. But as you get closer to retirement age, you’ll need to hedge your bets with more conservative investments.
• Potential payout. Of course, you’ll also need to consider the potential payout of each investment. Low-risk investments tend to be safe, but they offer a much lower return than many of their higher-risk counterparts.
• Diversification. A diversified portfolio is a collection of investments that are guarded against risks and volatility. Holding many different assets can protect you from crashes and crises that come from any single area. When these goals change, your portfolio should change to reflect it.

Assets to Consider

These are some of the most common assets to consider when rebalancing your portfolio:

• Stocks and ETFs. Stocks allow you to invest in public companies, purchasing a “share” of the company in hopes that the price will rise—you may also be able to make money on dividends. Of course, individual stocks can be risky, so many investors consider exchange traded funds (ETFs) that allow them to invest in many stocks at once.
• Bonds and bond funds. Bonds are a lower-risk, lower-reward investment that offer a fixed percentage return. You can also invest in bond funds, which allow you to invest in many different bonds simultaneously, reducing your already-low risk even further.
• Real estate and REITs. Real estate is a common investment for people looking to hedge their portfolio against the volatility of the stock market. And if you don’t like the idea of buying real property, you can invest in real estate through real estate investment trusts (REITs).
• Precious metals. Precious metals like gold and silver are some of the most common alternative investments, offering investors a perceived safe haven.
• High-yield accounts. You can also hold at least some of your portfolio in high-yield savings accounts or money market accounts. These tend to offer low returns, but even lower risk. Understanding the levels of risk and potential payoff offered by each of these assets is crucial to rebalance your portfolio successfully.

How to Rebalance a Portfolio

So what steps should you take to rebalance your current portfolio?

1. Consolidate and review your investments. First, collect all your investments in one place. If you have accounts on many different platforms, this is your chance to bring them altogether. What is your net worth and how is it distributed?
2. Evaluate your current risk profile. Next, you’ll want to evaluate your current risk profile. What are the riskiest investments in your portfolio, and what percentage of your portfolio do they represent? Is there any kind of financial event that could devastate you? Write down the percentage of your holdings in each major area of investment.
3. Establish your current goals (and how they’ve changed). Next, think about your current goals and how those goals have changed since the last time you did an analysis. Are you getting older, and more interested in favoring stability over risk? Are you now thinking about buying a house or making another major financial move?
4. Sell assets to raise funds. If you’re choosing to rebalance at least some of your portfolio, you’ll probably want to sell some of the assets you no longer want. Sell off gradually if you can, so you’re not exposed to the peaks and valleys of the market.
5. Invest in new assets. With your new funds, invest in new types of assets meant to round out your risk profile; if you do this, make sure you employ dollar cost averaging (DCA) to ensure you get a decent entry point.

All that’s left is to decide when to rebalance your portfolio—and how often to do it. For most investors, it’s a good idea to check up on your portfolio balance at least once a year. However, if you’re retiring soon or if your attitudes change, you may want to visit your investments more frequently.