No matter your risk tolerance or investment style, the past two years have been a wild ride for both stock and bond markets. If you’ve been invested during this time the chances are your portfolio has shifted, and possibly in ways that no longer align with your original asset allocation.
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Even if you feel confident in your current setup, now is the perfect time to reassess. Beyond just market performance, factors like your age, financial goals, account types and tax bracket may signal that a portfolio adjustment is due.
Here are four reasons to rebalance and diversify your portfolio — because you might need to do more than you realize.
You Can Pare Back Your Winners & Boost Your Losers (or Cut Them Loose)
Traditional portfolio rebalancing simply means returning your asset allocation to its original model. Imagine, for example, that you design a portfolio in line with your investment objectives that allocates 70% to stocks and 30% to bonds. If, for example, the stock market has had two consecutive years of 20%-plus returns, your stock allocation is likely now too heavy.
Perhaps your actual portfolio now sits with an allocation of 82% to stocks and just 18% to bonds. To rebalance, you could sell enough of your stocks to shrink that allocation back down from 82% to 70%. In that case, you’d also have to buy more bonds so that your allocation rose to the desired 30% from the current 18%.
As money expert Ramit Sethi explained in an article, rebalancing your portfolio annually “enforces a strict ‘buy low, sell high’ strategy that can enhance returns over time.” By definition, if your portfolio is out of whack due to outperformance in one area, you’d be selling those assets at a high level. Simultaneously, you’d be reinvesting the money into the underperforming sectors of your allocation, or “buying low.”
Important to note, however, is that sometimes your portfolio might get out of whack simply due to underperformance. This could impact everything from your asset mix to the time horizon of your long-term goals.
If your stock allocation falls from 80% to 65%, for example, it might be due in large part to a single stock losing half its value. In that scenario, while you should still buy stocks to boost your allocation, you might want to part with the single stock that is dragging down your portfolio — and might inflict even more damage in the future.
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It Helps You Incorporate Your Tax-Advantaged Accounts
Outside of navigating market volatility, managing risk and seeking higher returns, there is another difficulty investors face when rebalancing: taxes. If an investor sells an asset for a gain, they have to pay capital gains taxes. This isn’t always factored into the investment plan.
To minimize that tax burden of reallocation, start by making moves in your tax-advantaged accounts, such as your IRA or 401(k). That way, any positions you sell will not trigger tax consequences.
Imagine, for example, that your IRA has $100,000 equally balanced between stocks and bonds. For simplicity’s sake, assume you also have a taxable investment account worth $100,000, but with an allocation of 80% stocks and 20% bonds. If you want to maintain an overall balance of 50% stocks and 50% bonds, you can adjust your IRA so that it holds 20% stocks and 80% bonds. Then you can maintain your overall blend without paying taxes on your rebalance.
Another option to rebalance, according to Vanguard, is to direct new purchases in taxable accounts into underweight categories.
It Sparks Consideration of Overseas Allocation
One of the rebalances that many experts advise — but that many investors overlook — is allocating more assets to international stocks and bonds.
Andrew Molinet, senior portfolio strategist of the portfolio construction and strategy team at Janus Henderson, for example, said in an article that international stocks trade at a discount to U.S. stocks, even though there are some very high-quality companies overseas. He also noted that 82% of the world’s top-performing stocks over the past decade originated overseas, something that many investors may not even know.
Rebalancing with an international allocation can potentially reduce your portfolio’s volatility while increasing its return.
It Integrates Your Required Minimum Distribution, If Applicable
If you will be taking a required minimum distribution (RMD) from your retirement account this year, that’s a perfect time to rebalance your portfolio, according to experts at Morningstar. By taking money out of your overallocated positions, you can rebalance your account without having to make any purchases. Meanwhile, you’ll also fulfill your RMD requirement.
For example, imagine that you had a $100,000 IRA with a 52% stock and 48% bond allocation, but you preferred a 50%-50% balance. If your RMD for the year were $4,000, you could simply take that out of your stock allocation. That would leave you with $48,000 in stocks and $48,000 in bonds, which would achieve your equal balance while taking out enough money to satisfy your RMD.
Caitlyn Moorhead contributed to the reporting for this article.
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This article originally appeared on GOBankingRates.com: 4 Reasons You Should Adjust Your Portfolio More Often Than You Think
