Here's Why You Should Rebalance
Keep your portfolio's risks in check with this one simple trick.
Over the past decade, investors have become accustomed to U.S. stocks hitting new all-time highs. While the extended bull market has been a boon to portfolio balances, investors that have let the market's rise drive their equity allocations higher may now be holding riskier portfolios than they initially signed up for. For example, a hands-off investor that built a traditional 60/40 portfolio 10 years ago would have a portfolio that's closer to 80% in equities as of the end of 2019. It's possible our hypothetical investor's risk tolerance skyrocketed along with the stock market, but it's more likely that the current portfolio no longer resembles an appropriate blend of risky and safe assets.
Rebalancing, or selling a portfolio's best performers to buy the worst performers periodically, is one of the best ways to protect against market movements altering a portfolio's risk profile. The advantages of rebalancing are especially apparent in tax-favored accounts, such as IRAs or 401(k)s, where tax implications are not a concern. Rebalancing may also be prudent in taxable accounts, but the advantages aren't as straightforward, as it may trigger capital gains taxes depending on the investor's income level and capital gains exposure. As such, this article evaluates the merits of rebalancing in tax-favored vehicles.