Home > Personal Finance > The Balancing Act: Are You Taking Too Much Risk With Your Money?

Comments 0 Comments

Portfolio rebalancing is simply the buying and selling investments in a portfolio to make the current asset allocation match the original asset allocation. Asset allocation is the mix and weightings of investments that make up your portfolio.

The two primary asset classes are equities (stocks) and fixed income (bonds). Generally, stocks are more volatile, and are therefore considered more risky assets than bonds. Over the long term, however, stocks have shown tendency to outperform bonds. So a younger person with more years ahead of him to recover from losses may choose a portfolio more laden with stocks, while an older person may weight her portfolio towards bonds. (You can monitor your financial goals like building good credit for free on Credit.com.)

When Should You Rebalance?

Throughout the year, the initial weighting of your chosen allocation can change due to unequal market performance among asset classes. When this happens, your portfolio may no longer match your appetite for risk.

Let’s assume that a person started out with a portfolio of 60% stocks and 40% bonds. If equities outperformed bonds, then at the end of the year, the allocation may end up with 70% stocks and 30% bonds. When this happens, it is time to consider rebalancing the portfolio back to the original allocation. Another reason to rebalance is if your investment goals or tolerance for risk has changed from the time you created the portfolio.

Rebalancing is counterintuitive. It forces us to sell better performing asset classes and buy underperforming asset classes. Instinctively, we want to keep over-performing assets in our portfolio and sell under-performing ones. Keep in mind, however, that one of the primary goals of investing is to buy low and sell high. Rebalancing is an unemotional process that forces the investor to buy asset classes when they are low and sell when they are high. While it cannot guarantee a profit, consistent rebalancing does tend to lower overall portfolio risk over the long term.

You should rebalance your portfolio at least annually or when an asset class is 5% or more out of balance. More frequent rebalancing can reduce portfolio volatility even further (but also can limit returns). Some investment plans can be set up to automatically rebalance your portfolio at predetermined time frames.

Avoiding Tax Consequences

A very important consideration in determining when and how to rebalance is income taxation. If you are rebalancing within your IRA or your 401(k), then this is not a concern since all taxation is deferred until the money is actually withdrawn from the plan. Conversely, a taxable account will necessitate that you consider the effects of taxation on your transactions. Generally, if you sell an investment with a gain, you will have to pay income tax on any profit. If the investment was held for more than one year, the income tax rate will generally be at the lower capital gains rates. Still, paying any income tax on investment performance will lower your after-tax investment return.

There are a few ways to minimize the effects of taxation when rebalancing. If you have both taxable and tax-deferred portfolios, you can implement the rebalancing as if the two accounts were one. Consider only selling assets inside the tax-deferred account so that your overall asset allocation between both accounts will match your tolerance for risk. This will probably make each of the individual accounts look skewed when considered separately, but when viewed together, you can maintain a balanced portfolio with minimal taxation.

If you only have a taxable account, you can try to match the sale of investments with gains to the sale of the assets with losses. If you can do this, then the gains could be offset by the losses, thereby reducing or even eliminating any taxable gain. Matching capital gains with capital losses can be complicated, so you may want to secure the help of a professional before you place any trades. (Full Disclosure: I am a Certified Financial Planner who advises clients on investment decisions.)

Another option is to allocate all future investment contributions to the underweighted asset classes in order to increase their value while leaving the over-performing assets alone. It will take a bit longer to balance the portfolio, but you will do it without the burden of taxation from selling or the complication of capital gains and losses.

While I have only mentioned stocks and bonds, rebalancing can also include sub-asset classes, like small company stocks, international stocks, emerging markets and high-yield bonds. If you have allocations to sub-asset classes, you should also consider their relative allocation when rebalancing.

More Money-Saving Reads:

Image: Alberto Bogo

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other articles on Credit.com News & Advice may also be offered through Credit.com product pages, and Credit.com will be compensated if our users apply for and ultimately sign up for any of these cards or products. However, this relationship does not result in any preferential editorial treatment.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Our Owners

Credit.com is owned by Progrexion Holdings Inc. which is the owner and administrator of a number of business related to credit and credit repair, including CreditRepair.com, and eFolks. In addition, Progrexion also provides services to Lexington Law Firm as a third party provider. Despite being owned by Progrexion, it is not the role of the Credit.com editorial team to advocate the use of the company’s other services. In articles, reporters may mention credit repair as an option, for example, but we’ll also be sure to note the various alternatives to that service. Furthermore, you may see ads for credit repair services on Credit.com, but the editorial team isn’t responsible for the creation or implementation of those ads, anymore than reporters for the New York Times or Washington Post are responsible for the ads on their sites.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team