Rebalancing: How to Make Sure Your Portfolio Sticks With the Plan

Rebalancing: How to Make Sure Your Portfolio Sticks With the Plan
Rebalancing: How to Make Sure Your Portfolio Sticks With the Plan

When you're investing -- whether for retirement, college, or some other long-term goal -- one of the first steps is determining your asset allocation: What, exactly, you want to invest in, and how much. You'll spread your money between stocks, bonds and fixed-income options, and how much you dedicate to each depends on how much risk you're willing to take and when you expect to need the money.

Once you've settled on a strategy -- see this earlier article of mine for tips on picking one -- it's all about maintaining that strategy. And to do that, you need to rebalance.

Rebalancing is the ongoing process of bringing your portfolio back to your target asset allocation ratios. Because stocks tend to experience faster growth than bonds, without rebalancing, you could quickly find that you were over-exposed and taking too much risk. On the flip side, when stocks fall -- as they did in 2008 -- they tend to fall faster than bonds, which can easily lead to a portfolio that is too conservative to meet your goals.

Luckily, rebalancing isn't time or labor intensive. Here's how to keep your investments in line:

• Keep tabs on your portfolio. During shaky times, I always tell people to step back a bit. It doesn't help to track your portfolio's every dip and rise. But you do need to carve out some time to check in with your investments. Some people suggest doing it annually, others say quarterly. I say somewhere in between is fine. That way, if an asset class gets a little squirrelly, you'll be able to get things back in place before too much damage is done.

• Sell high, buy low. One huge benefit of rebalancing is that it effectively forces you to do what we know is an effective investment strategy: Sell some of your winners, and buy more of asset categories that haven't performed as well. A lot of people have trouble getting behind this: Why would you want to sell your winners? The answer is simple: It's one of the only ways to ensure you're not over-exposed to one segment of the market.

• Stick to the plan. It's easy to get caught up in the fluctuations of the market, and the temptation is always to chase high-performers. But the real way to come out on top is to go back to your roots, which in this case, means your asset allocation plan. "Most people think the best thing you can do is pick asset classes that will perform the best," says Mike Scarborough, president of Scarborough Capital Management. "But really, the most important thing is rebalancing back to the percentage of exposure you want to have. Doing that consistently will have a far greater effect in the long run."

• Consider life-cycle funds. If all of this sounds like the last thing you'd want to worry about, you have another option, but it requires some due diligence up front. Life-cycle funds, also called target-date retirement funds, which I've written about before, do the rebalancing work for you. You pick the date you plan to retire (or the date you expect to start withdrawing the money, in the case of college or other savings goals) and they automatically keep your investments in line to meet that goal. But such funds vary widely by company, and some are more aggressive than others. You need to look beneath the hood and make sure that the fund you've chosen is investing in a way that makes you comfortable.