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The Importance of Rebalancing Your Portfolio Thumbnail

The Importance of Rebalancing Your Portfolio

One of the most underused, overlooked and unappreciated practices in investing is rebalancing your portfolio on a yearly basis. There's an old saying that there's no such thing as a free lunch. Disciplined rebalancing, however, is as close as you can get to a free lunch. Let's explore why.

How To Balance Your Portfolio Initially

When you become a client of 80/20 Financial Services, we sit down together to create your diversified portfolio divided among several different asset classes. For this example let's say we decide to invest your retirement money into five different mutual funds within your portfolio. We also decide to divide the money equally so that we put 20% of your retirement money into each of those five mutual funds.

Ex. You retire with $1,000,000 available to invest. We could distribute that money as follows:

Large Cap Growth Stocks $200,000 or 20% of your portfolio

Large Cap Value Stocks $200,000 or 20% of your portfolio

Small Cap Growth Stocks $200,000 or 20% of your portfolio

Small Cap Value Stocks $200,000 or 20% of your portfolio

International Growth & Value Stocks $200,000 or 20% of your portfolio

Why Rebalance Your Portfolio

During the year what happens in the real world is that these mutual funds will start slipping out of balance. Some of the funds will do better than others which sounds good until you realize that more of your money is drifting into funds that are becoming overvalued. And that you have less money in mutual funds that have become attractively cheap or undervalued.

After the first year of retirement your portfolio now looks like this:

Large Cap Growth Stocks $250,000 or 23.6% of your portfolio

Large Cap Value Stocks $220,000 or 21% of your portfolio

Small Cap Growth Stocks $190,000 or 18% of your portfolio

Small Cap Value Stocks $170,000 or 16% of your portfolio

International Growth & Value Stocks $225,000 21% of your portfolio

Your total portfolio is now valued at $1,055,000 but your percentages are no longer 20% in each mutual fund. That means it's time to rebalance!

When To Rebalance Your Portfolio

Once a year, around the same time, we will rebalance your portfolio. Meaning we will return the portfolio to it's five mutual funds at 20% each configuration.

The way we do that is to harvest some of the gains from the mutual funds that have increased and reinvest them into the funds that have decreased. Taking money out of mutual funds that have increased and reinvesting that money into mutual funds that have decreased is buying low and selling high. Which is the exact opposite of what the typical investor does on their own.

When we follow simple disciplines like diversification and rebalancing you and I become the tortoise in Aesop's fable. We may have to watch hares go whizzing past us at any given moment...but we know who ultimately wins the race.

You Need A Plan

At 80/20 Financial Services, we are retirement planners and we specialize in working with electric cooperative employees. We can help you answer questions like:

  • Should you take your cooperative's monthly pension or lump sum offer?
  • Do you have enough money between your R&S and/or 401k to retire?
  • Could you possibly retire at age 55?
  • Is your cooperative 401k invested correctly for your retirement goals?
  • Should you be investing in a Traditional 401k or a Roth 401k?
  • Are you contributing too much or too little to your 401k?
  • Should you quasi-retire from your cooperative?
  • Should you accept an early retirement offer from your cooperative?
  • When should you claim Social Security benefits?
  • How can you lower your tax bill in retirement?
  • How do you invest your retirement money so that you increase your income in retirement?
  • How do you create an income stream in retirement that is similar to when you were working?

I started this firm specifically to help electric cooperative employees with retirement planning. I worked for an electric cooperative for 11 years and I know your profession and benefit plans better than any other financial advisor will. You have excellent retirement benefits available to you. I can help you optimize those benefits while creating a retirement income and investing plan that aligns with your retirement goals.

Contact us to set up a consultation. The consultation is free and without obligation.

For more articles about retirement planning and investing, click here. You may also sign up to receive our weekly retirement blog here.

Thanks for reading!

Brian Coleman/Retirement Income & Investment Planner

80/20 Financial Services is an Independent Registered Investment Advisory Firm. We help Electric Cooperative Employees create their retirement income and investment plans.

Photo by Piret Ilver on Unsplash