A well-thought-out investment strategy includes a plan for tune-ups. Keeping your investment portfolio in sync with your financial goals and how much risk you’re willing to take can be especially important in times of uncertainty.
That’s where portfolio rebalancing—adjusting the investments in your portfolio to match your target mix of stocks, bonds, and cash—can help.
“A change in economic conditions, market volatility, or large market moves—upward or downward—can significantly alter a portfolio’s risk/reward profile,” explains Mike Taylor, CFA, Vice President and Investment Strategy Analyst with Wells Fargo Investment Institute. “Portfolio rebalancing could be key to staying on track by taking profits from current investments and reallocating them into assets that have underperformed.”
Here, Taylor shares three more potential benefits of rebalancing your portfolio.
1. It could ease your fears.
It’s natural to feel fear in times of crisis, but you should not let it drive your financial decisions. “Fear can be one of the biggest obstacles to meeting your long-term goals,” Taylor says. For example, fear could cause you to sell during a market decline, instead of seeing it as a time when you could purchase additional stocks at a lower price. Of course, actions like this depend on your goals and when you hope to achieve them.
“We highly recommend meeting with a financial advisor who has the expertise and perspective to help you understand where your portfolio is now and walk you through the different possible scenarios to help reduce financial worry,” Taylor says. He also hopes that recent events will encourage investors to make time for a portfolio checkup at least once a year. Part of that discussion should include tax implications related to rebalancing your portfolio.
2. It could mitigate extreme ups and downs.
Market fluctuations can result in a significant drift away from your financial goals. For example, in the first half of 2020, stocks dropped precipitously, but bonds showed less of a decline. This left many investors with a larger percentage of their overall investments as bonds. Failing to rebalance at that point could have meant a longer recovery overall, as bond growth is typically much slower than stock growth over time. In this example, rebalancing is like planting seeds, Taylor says. “By moving some of those profits back into stocks, your portfolio may have room to grow more quickly and evenly.”
Rebalancing your portfolio can reduce risks during robust economic times as well. “In a bull market, higher-risk assets like stocks typically earn higher returns and become a greater portion of a portfolio,” Taylor says. “Left unchecked, this can increase the overall risk.” Case in point: An investor who entered the second quarter of 2009 with a 60/40 split of stocks and bonds would have had an 84/16 split by the time the pandemic took hold, if the portfolio had never been rebalanced1 .
“By regularly rebalancing back to your strategic targets, you can mitigate that volatility and possibly allow for smoother returns over time,” Taylor says.
3. It could help you meet your long-term goals.
“Rebalancing can help investors stick with their long-term strategies,” Taylor says. “Working with a financial advisor can help you determine whether your strategic asset allocation is still appropriate for your investment goals, risk tolerance, and time horizon—when you hope to achieve those goals.”
Having this conversation during a financial crisis could be particularly vital for small-business owners and people who have experienced a furlough or layoff. It could be that these investors might benefit from hearing what a financial advisor says about strategies to help protect assets or maintain investment income, which could include considering investments that pay dividends or looking for options to provide greater liquidity, Taylor says. In some cases, making some funds more easily accessible in the short term could help in the long term.
1 Sources: Morningstar Direct, Wells Fargo Investment Institute; March 31, 2020. In this example, stocks are represented by the S&P 500 Index and bonds by the Bloomberg Barclays U.S. Aggregate Bond Index. Market cycle illustration is for the period March 9, 2009, to March 31, 2020, with a starting allocation of 60% stocks and 40% bonds on March 9, 2009. Index return information is provided for illustrative purposes only. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and generally do not reflect deduction for fees, expenses, or taxes applicable to an actual investment. The S&P 500 Index is a market-capitalization index composed of 500 stocks generally considered representative of the U.S. stock market. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based index that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results.
Wells Fargo Investment Institute, Inc., is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.