The Ultimate Guide to Portfolio Rebalancing Strategies
Portfolio rebalancing is a crucial aspect of maintaining a healthy investment portfolio and keeping your target allocation on track. By periodically adjusting the allocation of your clients’ assets, you can ensure that your investments align with their risk tolerance and long-term objectives.
Rebalancing is typically done account by account, making periodic adjustments as each account drifts away from the target asset allocation. In this post, however, I’ll argue that rebalancing at the household level, instead of the account level, is the best way to influence future returns.
Rebalancing at the household level means a more tax-efficient rebalance. This approach focuses on minimizing taxable events while still achieving the desired asset allocation as we look across all account types. It can help you make the most out of your clients’ investments by reducing their unnecessary tax liabilities.
Over time, market fluctuations, withdrawals, or deposits may cause deviations from clients’ target asset mix. Regularly rebalancing ensures that their investments stay on track and they maintain a well-diversified portfolio that’s in line with their goals and risk tolerance.
When to Rebalance Your Portfolio
There are three key events when it’s possibly time to consider a portfolio rebalance.
First, when a client makes a portfolio withdrawal. Removing funds can affect their target allocation, so rebalancing after a large withdrawal may be necessary. If a tax-efficient withdrawal is executed, this lowers the likelihood that a rebalance is needed afterward.
You should also consider rebalancing when clients are depositing funds into their portfolio. This can be done by adding funds or reallocating assets to ensure that their portfolio stays in line with their long-term goals. Similarly to withdrawal, a large deposit can affect their target allocation, and investing any deposit in the most tax efficient way is key to maintaining the target.
Finally, it’s important to account for market changes and periodically adjust allocations accordingly. This means responding to fluctuations in the market by making necessary adjustments as a portfolio drifts out of alignment with the target. This is where a multi-account, household portfolio rebalance especially comes into play.
Rebalancing after a portfolio withdrawal
A portfolio withdrawal is an important time to consider rebalancing and measure the drift from the target asset allocation.
For example, imagine that a retired couple needs to replace the roof of their house. They can withdraw the money needed for the repair, but that large withdrawal can throw off their target allocation. If they don’t rebalance their portfolio following a large withdrawal like this, their allocation can end up with a higher risk tolerance than they are comfortable with as retirees, leaving them vulnerable to market fluctuations.
Alternatively, when clients withdraw funds, you can help them reallocate the newly drifted assets to other areas that may provide better returns or align more closely with their changing financial goals.
By understanding and analyzing allocation changes as a result of portfolio withdrawals and ensuring they align with your clients’ overall investment plan, they can make informed decisions that will help maintain a balanced and diversified portfolio over time. Regularly reviewing and adjusting their withdrawal strategy will allow you to help them meet short-term financial needs while staying focused on long-term growth objectives.
Rebalancing with a portfolio deposit
Making regular contributions to investment accounts is a key step towards building a strong and prosperous portfolio. However, making an unusually large deposit can disrupt a target allocation.
For example, consider the case of a 30-year-old with a fairly risk-tolerant target allocation who receives a large inheritance. Depositing that money into their accounts without rebalancing could make their target allocation much more risk-averse – and cost them opportunity in the long run.
Rebalancing after a deposit helps maintain a balanced and diversified portfolio, ensuring that client portfolios aren’t overly exposed to any particular asset class or investment and that target allocations stay on track.
Accounting for Market Fluctuations
When accounting for market change, it’s important to regularly review client portfolios’ allocation and make necessary adjustments. This can help ensure that their portfolios are well balanced and diversified.
Over time, normal market changes can affect portfolio allocations. By keeping portfolios regularly rebalanced, you can ensure that those portfolios continue to reflect your clients’ ideal target allocations.
Here are six key points to consider when navigating market fluctuations:
- Stay informed: Keep track of the latest market trends and news that may impact your clients’ investments.
- Reassess risk tolerance: Evaluate clients’ risk appetite periodically and adjust their target asset allocation accordingly.
- Maintain diversification: Ensure your clients hold a mix of different asset classes to spread their risk.
- Set rebalancing triggers: Define specific drift thresholds or time intervals that signal when adjustments should be made.
- Be proactive, not reactive: Take action before significant deviations occur to maintain desired portfolio weights for your clients.
- Rebalance at the household level: Consider which assets are best placed in the available account types.
By incorporating these strategies, you can effectively manage your clients’ portfolios in response to changing market conditions.
Maximizing tax efficiency is crucial when it comes to rebalancing portfolios. Tax-efficient rebalancing involves making strategic rebalancing decisions to minimize the impact of taxes on investment values as well as your clients’ annual tax returns.
One strategy that helps make rebalancing more tax efficient is called tax-loss harvesting, where clients sell investments that have experienced losses to offset gains in other areas of their portfolio. By doing this during a rebalance, you can help your clients reduce their overall tax liability and potentially increase their after-tax returns.
Another approach to rebalancing is focusing on asset location, which involves placing different types of investments in accounts with varying tax treatments.
Avoiding Target Allocation Drift with Rebalancing
To avoid target allocation drift in a portfolio, you can use various drift correction techniques, which can help investors maintain a balanced portfolio by regularly adjusting their asset allocation to counteract any deviation from the target weights.
One common technique is the threshold-based approach in which investors set a predetermined threshold for each asset class. When an asset’s weight deviates beyond this threshold, rebalancing is triggered.
For example, if the target allocation for stocks is 60%, and it exceeds the threshold of 65%, the investor (or financial advisor, acting as fiduciary) would sell some stocks and buy other, under-allocated assets to bring the portfolio’s overall allocation back in line with the target.
Another technique is time-based rebalancing, where investors rebalance at fixed intervals, such as monthly or quarterly. This method doesn’t rely on specific thresholds but ensures that adjustments are made on a regular basis to prevent excessive drift.
Ultimately, these drift correction techniques offer proactive strategies for maintaining desired portfolio allocations and optimizing long-term investment returns.
Total Household Account Rebalancing with LifeYield
LifeYield provides firms and advisors with the technology to rebalance clients’ portfolios in the most tax-efficient way. LifeYield Multi-Account Rebalancing takes into account each of a client’s accounts – their total household assets – to determine the optimal location of each asset that is bought and sold.
This innovative approach allows investors and advisors to achieve their target asset allocation by rebalancing across all accounts within a household rather than within each account individually This approach can increase after-tax returns over time by up to 33% according to a study done by E&Y.
Here are four key features of Lifeyield’s household asset rebalancing approach:
- Comprehensive view: LifeYield technology achieves a holistic view of all the accounts in a household, including retirement, taxable, and held-away assets. LifeYield then takes account aggregation to the next level by recommending the optimal location for each asset across all accounts in the household.
- Efficient optimization: When considering all accounts together, LifeYield identifies the most tax-efficient trades to rebalance the portfolio while minimizing tax impact and transaction costs.
- Customizable preferences: Advisors can set preferences such as risk tolerance or investment restrictions, ensuring that the rebalancing aligns with clients’ individual goals and target allocation.
- Real-time monitoring: With LifeYield’s technology, investors and advisors can monitor the progress of rebalancing the portfolio in real time, making adjustments if necessary.
With LifeYield’s household account rebalancing strategy, achieving your target asset allocation has never been easier or more efficient.
Frequently Asked Questions
How often should I rebalance my clients’ portfolios?
You should rebalance portfolios based on your clients’ individual financial goals and risk tolerance. It’s generally recommended to review and rebalance a portfolio at least once a year, or whenever there are significant changes in the market or personal circumstances. This helps ensure that investments remain aligned with each client’s investment objectives and helps manage risk by preventing any one asset class from becoming too dominant in their portfolio.
Are there any tax implications associated with portfolio rebalancing?
There are indeed tax implications associated with portfolio rebalancing. When you rebalance a portfolio by selling securities that have appreciated in value, you may trigger capital gains taxes.
On the other hand, if you rebalance by buying new investments, you might have to pay taxes on any dividends or interest earned.
It’s important to consider these tax implications and include consultation with your clients’ tax professionals when analyzing and making any decisions about portfolio rebalancing.
How can I prevent a client’s portfolio from drifting away from its target allocation?
To prevent a portfolio from drifting away from its target allocation, you can take a disciplined approach of regular rebalancing. This involves periodically selling assets that have become overweight and buying those that are underweight to maintain the desired asset allocation.
By sticking to this strategy, you ensure that a portfolio remains in line with your clients’ investment goals and risk tolerance, helping them achieve long-term success.
Is there a recommended approach for rebalancing the total assets in a client household?
There is no one-size-fits-all approach for rebalancing the total assets in a household. It depends on their specific financial goals, risk tolerance, and time horizon.
However, a common recommendation is to review their portfolio annually and adjust it back to its target allocation. This involves selling some investments that have grown too much and buying more of the underperforming ones.
Regular monitoring and adjustments can help keep a portfolio aligned with a client’s desired asset mix.
What factors should be considered when rebalancing a client’s portfolio?
When rebalancing a client’s portfolio, you should consider several factors.
- First, assess their risk tolerance and investment goals to ensure alignment.
- Next, evaluate the performance of each asset class to identify any deviations from target allocations.
- Additionally, take into account market conditions and economic outlooks that may impact the portfolio’s future returns.
- Finally, consider transaction costs and tax implications when making adjustments.
By considering these factors, you can effectively rebalance a client’s portfolio to meet their objectives.
It’s important to strategically rebalance a portfolio in order to maintain a client’s target allocation and avoid drift from that target.
By using tax-efficient rebalancing strategies and tools like those available through Lifeyield, you can ensure that your client household assets are properly rebalanced.
It’s also crucial to regularly review and adjust your clients’ portfolios to meet their investment goals.
Monthly insights from our Chief Growth Officer, Jack Sharry
Get exclusive insights and interviews from around the industry