Invest Retirement

Your Portfolio Is Out of Whack. Here’s How to Rebalance It

Dayana Yochim  |  May 6, 2020

The coronavirus crash has done a number on long-term investment accounts. Portfolio rebalancing is about restoring balance.

If investment accounts were people, they’d be aghast at the state of their hair these days. We’ve got IRAs with unruly bobs, 401(k)s with lopsided bangs and brokerage accounts sporting patchy buzz cuts. That’s what happens to portfolios when the markets grab the pinking shears and go to town.

The coronavirus haircut that has ravaged retirement savings accounts will eventually grow out on its own. But it will still be uneven (or “unbalanced,” in investing terms). The only way to restore the proper mix of stocks, bonds and cash is by rebalancing your portfolio.

What is portfolio rebalancing?

Portfolio rebalancing simply means buying and selling investments to maintain a desired mix and weighting of assets. Let’s say you wanted 75% of your investment dollars in stocks and 25% in bonds. If the stock market took a dramatic hit, then your mix might shift to 50% stocks and 50% bonds. You would need to either sell some of your bond holdings and reinvest the proceeds to increase your exposure to stock, or you add new money to the portfolio and invest it in stocks. (We’ll get into specific portfolio rebalancing strategies in a moment.)

It doesn’t take a dramatic stock market event to throw your portfolio out of whack. Over time assets normally drift. Most of the time you need only rebalance and make minor adjustments once or twice a year to bring the mix of assets back to the intended stater. 

Not all retirement investment accounts require reshuffling. If you’re invested in a target-date mutual fund (a popular choice in employer-sponsored retirement plans) or are using an automated investment service (a robo-advisor like Betterment, Ellevest, etc.), you get a pass. Investments within a target-date (or lifestyle) fund are automatically adjusted to maintain the target mix. And rebalancing is included as part of the portfolio management service at robo-advisory firms. 

If you choose your own investments and your money is spread across mutual funds (including index mutual funds), stocks, bonds and other assets, here’s how to restore order to your portfolio.

1. Revisit your target asset allocation plan (or set one now)

Asset allocation — how much you hold in different types of investments — is based on your tolerance for risk. If you already have a model of how the slices of your investment pie should be portioned, great. Don’t change it. As tempting as it is, now’s not the time to pull back on your exposure to the stock market, especially if you have a long-term investing time horizon (as in 10 or more years). 

If you haven’t thought much about the mix of investments you own, a quick way to calculate an age-appropriate allocation plan is to subtract your age from 110. That’s the percentage of your long-term savings you should devote to equities (stocks, stock mutual funds, exchange-traded funds or ETFs). Within equities, you also need to diversify among sectors, regions, company size and industry. The remainder should be in bonds and cash equivalents. 

Getting more granular within asset classes sounds complicated, but there are plenty of guidelines to help. A target-date mutual fund that’s closest to your target retirement can be a good guide. Let’s say you want to retire in 30 years. Take a look at the asset allocation breakdown of investments in the Fidelity Freedom 2050 fund. Currently 50% of the portfolio is dedicated to domestic equities (further broken down among large, medium and small companies as well as growth and value stocks), 39% is in a mix of developed and emerging market international stocks, and 7% in bonds, T-bills and debt. With that roadmap in mind…

2. Review your current investment mix

Sign into your investment account (your 401(k) portal, brokerage account for your IRAs or regular brokerage account) where you can see a percentage breakdown of your investments by asset class. Compare your current allocation to your target allocation. 

It is very likely that your position in stocks is dramatically underweighted, thanks to the coronavirus market crash. And while the past several weeks have erased some of the losses, it will likely be a while before equities return to their former glory — and proper stature in your portfolio — on their own. Once you’ve identified the biggest culprit behind the shift in balance, you can start to move back toward your original allocation plan.

3. Make incremental adjustments to restore balance

Typically the advice is to make adjustments when a single asset class shifts more than 5%. But you don’t want to react to every short-term price movement, especially in a volatile market like we’re in right now. As JJ Kinahan, chief market strategist at TD Ameritrade, recently told HerMoney, take baby steps as you rebalance your portfolio: “If you need to adjust something, sell a certain sector, or buy another sector — do about 25% of it.” Wait a while (several weeks or months), see how things evolve, and then lather, rinse and repeat.

There are several rebalancing strategies you can use either individually or combined: 

  • Direct new contributions into underweighted assets. You can build back up your positions with your monthly or quarterly retirement savings deposits without having to sell out of any assets to free up cash. 
  • Sell overweighted positions and use the proceeds to replenish underweighted ones. The downside of this right now is that by selling you could be locking in a loss. 
  • If you are retired and drawing income from your retirement accounts, withdraw funds from overweighted investments first.  

Many 401(k)s let you set up automatic rebalancing on a schedule or click a button to rebalance your portfolio at any time. If you haven’t rebalanced in the past six months, do it now. Just don’t overdo it: Twice a year — quarterly at the most — is enough for most people.

4. Include all of your investment accounts

It’s easy to accumulate a small collection of investment accounts, including current and former workplace 401(k)s and 403(b)s, IRAs (Roth and traditional) and maybe a brokerage account or two. All of the assets in all of your accounts together make up your “portfolio” and are included in your asset allocation plan.

How you handle rebalancing when you have multiple investment accounts depends on account balances, types of investments held and tax treatment (taxable brokerage versus tax-favored IRAs). 

  • If they all have similar balances and/or the same tax treatment, you can treat each as a mini portfolio and deploy the same target allocation model in each. With this approach, the same mutual fund you chose in your 401(k) may not be available in your IRA. Find one with a similar investment objective (and, as always, the lowest management fees possible). 
  • If there’s an account that’s concentrated in a certain type of investment (e.g. your Roth IRA holds mainly individual growth stocks), you may need to trim the growth stock holdings in your other accounts to maintain the proper overall balance.

The bottom line on portfolio rebalancing

Asset allocation is all about finding the right balance between risk and reward. Right now the risk bell is drowning out the reward one, but it won’t always be that way. (We’ve devoted a lot of virtual ink to reminding everyone that stock market corrections and crashes are inevitable — and that they eventually end.) The key to surviving and coming out ahead on the other side is to stick with the long-term strategies, like your asset allocation targets, put in place during calmer times. 

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