Rebalancing Guidelines

Effective rebalancing allows you to remove much of the tension involved in monitoring your investments. While you can certainly take advantage of all the Scottrade tools that allow you to keep daily tabs on your investments, such as the Mobile app, streaming quotes, the Gain/Loss & Tax Center, etc., you shouldn't feel the need to tweak your portfolio constantly.

Instead, you may want to consider these Morningstar guidelines:

Guideline 1 - Rebalance only on an as-needed basis.

Morningstar isn't saying you shouldn't look at your portfolio in the meantime, but resist the urge to tinker. You'll save yourself unnecessary labor – and money - if your portfolio includes taxable accounts.

Keep in mind that rebalancing requires paring back the winners, which means realizing capital gains and, for the taxable investor, paying Uncle Sam.

Some people like to rebalance on a calendar-year basis—say, every December. Another strategy is to conduct a thorough checkup of your portfolio once a year, but rebalance only when your portfolio's asset allocation is out of sync with its targets. For example, you might only rebalance when your portfolio's allocation to stocks and bonds diverges from your target allocation by five percentage points. You can specify ranges for your allocations to each asset class. For example, if your target allocation to stocks is 55%, you may let the weighting go as high as 60% or as low as 50% before making changes. Hands-off investors could give their portfolios an even longer leash, rebalancing only when their allocations to the major asset classes diverge by 10 percentage points relative to your targets.

Guideline 2 - If you rebalance just one thing, consider making it the stock/bond split.

Cash and bond stakes can be key to helping keep a portfolio's risk in check. So, if you don't want to take the time to rebalance your entire portfolio on a regular basis, consider restoring your cash and/or bond positions to your intended mix.

Guideline 3 - Be aware of your tax situation.

Keeping your portfolio's volatility in line isn't satisfying if your rebalancing strategy means you also wind up with poor after-tax returns. Here are three things you can do to help minimize taxes:

  1. Consider rebalancing less frequently – say every 18 months instead of every year. That being said, you should always take the market into consideration regardless of your timeframe for rebalancing. If you're not due to rebalance for another six months but there have been huge shifts in the market, you may want to consider rebalancing a little sooner. On the other hand, if you're scheduled to rebalance but your asset allocation isn't too far out of alignment with your target mix, you may consider waiting.
  2. Consider using new money--say from a bonus or a gift--to restore balance. When adding fresh dollars to a portfolio, you can add to your under-performing investments to avoid the tax consequences of selling the winners. If you don't have new money to put to work, you may want to consider having your funds' income and capital-gains distributions paid as cash, then using that cash for rebalancing.
  3. If you need to scale back in certain types of investments that you own in both taxable and tax-deferred accounts, you may want to sell the securities in the tax-deferred accounts first. That way, you'll limit how much you pay in capital-gains taxes.

Read Next: Modern Portfolio Theory

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