A strategically balanced investment portfolio is  a moving target. The optimal balance can shift with individual circumstances or asset performance. Steve Giles explains how occasional rebalancing can help investors more objectively consider when and how to readjust their holdings. Steve spoke with Joel Dresang in a Money Talk Video. A transcript of their conversation follows.

Joel:  Steve, we talk a lot about the importance of having a balanced investment portfolio, but with the run up of stock prices since November, a lot of investors might find that they’ve got more stocks in their portfolios than they expected. So let’s talk about rebalancing, but first remind us why balance is important to begin with.

Steve: Joel, balance is very important because it determines that risk/reward relationship in your portfolio. Keep in mind, we own stocks for longer-term appreciation and longer-term growth, but of course, we own bonds for short-term distributions, safety and liquidity.

Joel: So, balance can be sort of a moving target that shifts now and then. How do you determine at what point to consider rebalancing?

Steve: Well, I think if there are some circumstances that may change what your original allocation was. As you get closer to retirement, you may want to shift from a portfolio geared more for growth and appreciation, into one geared more for income and safety of principal.

The other thing, of course, that’s going to drive rebalancing might be a particular asset class, or a particular sector that may be a bit overvalued from what your starting initial balance was in the first place.

Joel: How about an example?

Steve: Well, let’s assume that we determine your asset allocation mix should be 60% in stocks and 40% in bonds. Using a tool like Morningstar Snapshot, we can dial in and determine if your 60% stock allocation has become more or less than what you had originally started with.

Let’s say the stock market does very well, and you now have 70% of your investments invested in stocks. That would, of course, trigger rebalancing, because you have more than what your original plan had indicated. And it makes it easier to lock in some of those gains, and move that money back over into bonds to rebalance back to your original 60/40 mix.

Joel: So what do you consider out of whack for a balance?

Steve: Well, I think anything out of whack would be something more than a 5% to 10% swing in an asset class in your portfolio. Anything less than that, you may want to let your winners run. Anything more than that, though, would suggest that you’re going to be out of balance with what your original allocation was.

The reason why this is important, Joel, is because if you had determined a 60/40 mix to be appropriate for your risk/reward relationship and what you’re hoping to accomplish with your investments. If you now have 70% of your portfolio in stocks, you’re subjecting yourself to a lot more risk and a lot more volatility than what you had originally intended.

It cuts both ways though. If you had the portfolio go from 60% in stocks down to 50% in stocks, you may not be taking enough risk longer term to meet your goals.

Joel: How do you choose what to sell to get that balance back?

Steve: Well, I think it starts with where we are in the business cycle. You have to look at what’s done well, you have to understand where we might be with respect to the business cycle, and then reposition into those areas where we see opportunities moving forward.

The other way is to just basically see what’s done very well and take some money off the table. If you have a particular asset class that has appreciated very rapidly, I like taking that money and locking in those gains.

Joel:  What do you do with the proceeds?

Steve: A lot of times, we’ll reposition that money into areas in the portfolio where we see opportunities to get back into that original mix that we had determined for your asset allocation. Other times, we might be taking proceeds to meet your income needs in retirement, because you’re taking out a monthly distribution.

Joel: How do you convince investors to sell off assets that are doing well?

Steve: People can be very emotional with their investments Joel, and I think it’s important to remind them to focus on what their original strategy was. If we come up with an objective investment allocation, it helps to remove emotion from the equation when we need to rebalance.

Joel:  What warnings do you have about rebalancing?

Steve: Well, one of course is the cost. Every time you sell a stock or you sell a mutual fund, that’s going to incur some kind of trading charge. So, we have to be sensitive to not over rebalancing.  The other cost, of course, is capital gains that you might incur on a taxable account.

Rebalancing, though, is important. I think that investors need to recognize that rebalancing, when done properly, is a very important component to a well-balanced financial plan. My reminder would be, don’t base it on your emotions, and stick to your plan longer term.

Steve Giles is vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Jason Scuglik and Peter May

Learn more

When Should I …rebalance my portfolio? by Art Rothschild
When and why to rebalance, a Money Talk Video with Brian Kilb
Seeing how your equities are balanced, a Money Talk Video with Kyle Tetting
Talking Money: The importance of balance, a Money Talk Video
The case of the balanced portfolio, by Bob Landaas
Beginners Guide to Asset Allocation, Diversification and Rebalancing, from the U.S. Securities and Exchange Commission
Rebalancing Your Portfolio, from the Financial Industry Regulatory Authority

(initially posted April 25, 2017)

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