Q: During my career, I followed your advice and used dollar cost averaging to build my retirement income. Not surprisingly, my portfolio now needs rebalancing. I want to get back to a 60-40 stocks-to-bonds ratio. Do you recommend a one-time transfer or an incremental “dollar cost” rebalancing? - Richard, Marco Island, Fla.
A: With one important caveat, I would rebalance all at once. The caveat? I’m assuming your retirement savings is in tax-sheltered accounts like 401(k)s and IRAs. You don’t have to worry about Uncle Sam’s levy when you rebalance in a tax-sheltered plan. The preferred rebalancing strategy with a taxable portfolio is to return to your desired asset allocation with new money rather than paying taxes on selling existing investments. You can accelerate the process by culling the portfolio for tax losses to offset gains and minimize the tax bite.
Rebalancing is a worthwhile discipline. No one knows how long sizzling markets will stay hot and what assets will fizzle by year-end, let alone five years from now. That’s why I favor investment strategies that don’t rely on forecasts. Among those strategies is rebalancing. (Diversification and low fees are two other strategies.) You stack the long-term odds in your favor by concentrating on what you can control. Rebalancing minimizes your downside risk.
The key assumption with rebalancing is that you have created a well-diversified portfolio that reflects your capacity for absorbing financial risk. Finance research suggests that asset allocation — how much you put into stocks, bonds, cash and so on — is the main determinant of your portfolio’s long-term performance. Portfolio rebalancing maintains your target asset allocation.
Professionals typically recommend rebalancing when your portfolio values shift by more than 5 percent. Still, for most people rebalancing once a year works fine.
One commonly recommended technique is to pick a date to review your asset allocation — for example, your birthday. However, since I can think of more enjoyable things to do on my birthday, perhaps tax time — April 17 — is a better choice. You have reviewed your household finances anyway in preparation for paying taxes. A certified financial planner that I interviewed years ago reviewed her portfolio on New Year’s Day since she wasn’t a football fan. Many finance companies have made rebalancing even easier by giving you the option of setting your parameters online for automatic rebalancing.
Chris Farrell is senior economics contributor, “Marketplace,” commentator, Minnesota Public Radio.