What does “Portfolio Rebalancing” mean?
There are many terms used in the finance world. You may have heard your financial advisor or someone you work with say they recently “rebalanced” their 401k or investment account. If you are unsure what this means or are wondering if this is something you should be doing, I hope that after reading this article, you will feel more confident in understanding this phrase and its importance.
A Simplistic Scenario Example
Suppose you have half of your retirement account in bonds (slow and steady) and half in stocks; you continually put money into your account and forget about it for three years. You open a statement and see the allocation is now 65% stock and 35% bonds. Without your knowing or doing so, the percent of your portfolio allocated to stocks is now 15% higher than you had three years ago. This is most likely due to the difference in performance in the two investments; stocks did very well, bonds did ok, and the stock portion outgrew the bond side, and you now have a higher percentage in stocks. A portfolio rebalance would then be appropriate for you, and it would be done by selling 15% of the stock portion and putting that in bonds. It is straightforward and done for several reasons, which I will go into.
The Reasons
First
The first reason is to ensure that your portfolio's risk is being managed. In the above example, if you are a conservative investor and don’t want to have too much of your portfolio in stocks, then it is important to monitor your allocation to ensure that you don’t have more stock expenses than you are comfortable with.
Second
The second reason, which I believe is just as important, is to take advantage of the ebbs and flows of the market. In the Dave Ramsey vernacular, we believe that a diversified stock portfolio comprises growth stocks, growth and income stocks, aggressive growth stocks, and international stocks.
A Realistic Example
A perfect example of using the difference in performance of these different types of stocks to your advantage was 2022 and 2023. If you started 2022 with a 25% allocation to each of these four categories, you saw a significant difference in returns throughout the year. Most notably, growth stocks were down 29%, while growth and income were down only 7.5%. By the end of the year, you had much more money in growth and income than in growth.
So, it's time for a rebalance. This would mean selling some growth and income relatively high and buying growth stocks relatively low. This was the best possible action to take as 2023 was an excellent year for growth stock, up 42%, and a decent year for growth and income, up 11%.
The Benefits
By systematically performing a rebalance, you can take advantage of the opportunities the stock market gives you by buying low and selling high. This is one of the advantages of professional management. It can also be implemented in many 401k by signing up for an annual rebalance or a rebalance notification that the 401k provider will send out annually.
If you have any questions about your portfolio, be sure to reach out to your financial advisor. If you do not have an advisor but have questions or want to start investing, we have a team of financial advisors at Whitaker-Myers Wealth Managers with the heart of a teacher who is happy to help walk you through the process.
What Portfolio Rebalancing is, and its importance
August 12, 2024
Jake Buckwalter
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