When you start investing, your advisor builds a portfolio aligned with your personal investment objectives. Your target allocation takes into consideration your goals, risk tolerance and time horizon, among other things. Unless something in your life changes, your portfolio should continue to align with your objectives. However, this means revisiting your allocation and rebalancing when necessary to ensure you have a healthy mix of performance and risk level that align with your near-term and long-term goals for your wealth.
Out of balance
First, rebalancing is a regular part of maintaining a portfolio. The investments in your portfolio each grow at different rates. Typically, best-performing asset classes will grow at a faster rate, therefore taking up a larger proportion of your portfolio over time. This alone can skew a portfolio to carry more risk than you originally intended.
Sometimes, market fluctuations can cause your portfolio to become imbalanced. When certain style investments are in favor relative to others (whether they’re riskier or not), your portfolio allocation may start to drift and require rebalancing to restore the appropriate mix to achieve the diversification benefits initially designed.
Rebalancing methods
There are several ways to rebalance your portfolio. Integrating factors such as personal preferences, tax implications and costs associated with monitoring and trading is the best way to determine which method fits with your investment style.
Buy and hold is one way to approach portfolio rebalancing. Once your assets are invested, you make no changes and allow them to move freely with the markets. This means the assets with the highest returns (most likely those with the highest risk) will take up a higher percentage of your portfolio. This may mean the overall risk of your portfolio increases over time and is more prone to momentum reversing at times of market shifts.
Time-based or constant mix calls for asset class proportions to be brought back in line at regular intervals, most commonly annually or semi-annually. Rebalancing more frequently, like monthly or quarterly, may reduce the unwanted portfolio shifts but also lead to more transaction costs, paying taxes on short-term capital gains and a potential loss of returns if an asset class is not given sufficient time to appreciate.
Drift-based or contingent sets a threshold, known as a tolerance band, around each of the asset classes in your portfolio and rebalances whenever a threshold is breached. Bands can be relative or absolute. For example, setting a 10% relative band around a 40% allocation would trigger a rebalance at weights above 44% or below 36%, while a 10% absolute band would allow the allocation to drift up to 50% or down to 30% before rebalancing.
Common pitfalls
Following a rebalancing process will keep your investment goals at the forefront and help you avoid common behavioral investment tendencies. Three common behavioral finance flaws include:
Herd mentality: This is when you follow what everyone else is doing, which means selling assets that are underperforming and buying those outperforming. This is usually counterproductive to achieve the optimal performance of the portfolio as the price of assets might be distorted the most with crowded positionings.
Loss Aversion: Investors tend to fear losses more than they value gains. This can lead them to hold onto losing investments for too long, hoping they will recover, rather than rebalancing the portfolio to cut losses and reallocate funds more effectively.
Overconfidence: Investors can sometimes overestimate their ability to predict market movements. This can result in frequent and unnecessary adjustments to the portfolio, increasing transaction costs and potentially reducing overall returns over the long term.
Mental accounting: A portfolio should be viewed as a whole, instead of compartmentalizing each piece. This can cloud an investor’s judgement when it comes to making risk reduction decisions and prioritizing the portfolio’s long-term performance.
To avoid falling victim to common behavioral tendencies and help ensure your portfolio is set up for long-term success, speak to your advisor about how and when to rebalance and which method matches your investment style.
Rebalancing a non-retirement account could be a taxable event that may increase your tax liability.
Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.
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J.D. Power 2025 U.S. Investor Satisfaction Study, which measures overall investor satisfaction with investment firms, was released 3/20/25, based on investors surveyed 1/24-12/24, who may be working with a financial advisor. Based on 7,876 responses from Advised Investors, 1 company out of 24 was chosen as the winner. The award is not representative of any one client’s experience, is not an endorsement, and is not indicative of an advisor’s future performance. The study is independently conducted, and the participating firms do not pay to participate. Use of study results in promotional materials is subject to a license fee. J.D. Power is not affiliated with Raymond James. For J.D. Power 2025 award information, visit jdpower.com/awards.
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