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What is Portfolio rebalancing, why does it matter to you, and how is it handled at RetirementPlan.io?

Why do portfolios get out of balance?

The allocation of your portfolio assets to various asset classes (e.g. domestic equities, international equities, bonds, commodities, etc.) is a risk-based decision that has a huge impact on your portfolio performance over time. An investor should take stock of their own tolerance for risk, and set their portfolio allocations accordingly.

However, as time passes, the asset allocations within your portfolio will drift due to the differing performance of various asset classes. For example, say your portfolio at the start of 2014 included two asset classes, and had a total value of $10,000:

  • Domestic Equities: 50% ($5,000)
  • Bonds: 50% ($5,000)

By the end of 2014, let's assume that stocks return 6%, and bonds return 2%. The value of your assets on December 31st would be:

  • Domestic Equities: $5,300 (53% of $10,400)
  • Bonds: $5,100 (51% of $10,400)

It's easy to see that your portfolio allocations can drift quite far from their targets, especially over time.

What is portfolio rebalancing?

Portfolio rebalancing is the act of moving funds around within your portfolio to bring the asset allocation back in line with your target values. In the example above, this would mean the following:

  • Domestic Equities: Sell $100 (final value --> $5,200 / 50%)
  • Bonds: Buy $100 (final value --> $5,200 / 50%)

The dollar values above would need to be converted into # of units to buy/sell, by dividing by the unit price of each ETF/index mutual fund.

Fairly simple in this case as there are only two assets, and we have nice round numbers. In practice, it's good to have a spreadsheet handy to complete the calculations for you.

Why should I rebalance my portfolio?

The primary reason that your portfolio should be periodically rebalanced is risk mitigation.

As can be seen from the example above (where stocks hypothetically outperformed bonds), the investor's portfolio is now more heavily weighted towards bonds. Under the assumption that "stocks" have a higher historical volatility (risk) than "bonds", this portfolio now is riskier from the investor's perspective.

Rebalancing the portfolio would bring the assets back into line with their target allocations, and align the portfolio's risk with the investor's tolerance and ability to accept it.

There are also secondary reasons why you would want to rebalance your portfolio. Rebalancing has the effect of selling assets that have appreciated, and buying assets that have gone down in price. This helps to counteract "typical" investor psychology that leads to them buying assets that have gone up, and selling losers (trying to "buy high / sell low"). There are a number of studies that have looked at the potential excess return benefits that could be gained from regularly rebalancing your portfolio, however the results are mixed depending on the assumptions and time periods considered.

How does RetirementPlan.io handle portfolio rebalancing?

RetirementPlan.io helps you to determine an asset allocation that will meet your retirement objectives, and also be within your willingness/ability to tolerate risk. As time passes, you will want to maintain this asset allocation to keep your portfolio risk in check.

RetirementPlan.io will watch your portfolio, and notify you if it gets out of balance. We will check unit prices on your selected ETFs, and send you an e-mail that contains easy to follow instructions on how many units of each ETF to buy/sell in order to bring your portfolio back into balance, only costing you the trading commissions that your discount brokerage levies.

If you want to invest additional funds, we will help you to invest a target dollar value, while simultaneously rebalancing your portfolio and bringing it back into line.

As you can see - RetirementPlan.io does the heavy lifting for you from a portfolio rebalancing perspective, and allows you to focus on your higher level retirement goals.

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Brandon Parsons


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Brandon Parsons

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