Why Rebalancing Your Portfolio is Like Buying a Carton of Eggs
Who out there has bought a carton of eggs? I know that I have, and I am sure many of my readers have as well. It’s an everyday item in many a shopper’s cart. It’s so common that some may do it without thinking and thus could do it in their sleep. Like my son, for example, there’s a reason we call him “Clucky” – the boy loves eggs! We’re constantly buying them. Enough so that we’ve discussed many times how much money we might be able to save if we bought a few chickens. My question to you is ‘what is the first thing you do before putting that carton of eggs in your cart?’ If you’re like me you open the carton to see if all of the eggs are in good shape. You may ask what buying eggs has to do with rebalancing your portfolio, well it actually has a lot to do with it and the same checking mentality is vital to your overall investing health.
Check Before You Buy
For most of us, we’re not getting our eggs locally or fresh like some might be and as a result they’re shipped to whatever grocery store it is you buy them from. Eggs, like stocks, are a fragile thing. They can be altered by minor circumstances and can simply be unusable, or in the case of an investment not worthy to be held any longer. In regards to stock investments, or any investment for that matter, the slightest change or news item can alter its performance for some time. Left unchecked, this has the potential to put a good crimp on your investment portfolio. This is why so many in the personal finance world espouse the importance of rebalancing your portfolio annually so you can see what’s still a worthwhile holding and what should be thrown away.
Balance is Everything
I know some may argue that eggs are not good for your health, but I think they’re fine within moderation. Having a healthy well balanced diet is key to leading a healthy lifestyle and eggs are certainly a part of that. The same may be true of certain stock holdings in your investment portfolio. I’ve written about risk tolerance before and that is exactly why rebalancing your portfolio is vital to having a well-balanced investment approach. When it comes time to rebalance your portfolio it’s the perfect time to revisit your risk tolerance and see if your portfolio is out of balance. As the market ebbs and flows throughout the year, it’s highly likely that your portfolio is a little out of whack and needs some fine tuning to get back to an appropriate balance.
Rebalancing Your Portfolio is Key to Your Overall Investing Health
I know that rebalancing your portfolio is not sexy by any means and many bloggers worth their salt have written about it. The very reason why so many have written about is that it’s of utmost importance to your long term investing health. In many instances, like in your 401k, rebalancing your portfolio is extremely simple. Most 401k plans have a nice feature that allows you to rebalance annually with no work required from you. How easy is that? As stated previously, the stock market moves in various directions throughout a year. What started out as a 20% holding in a large cap fund might end the year as a 22-25% holding. While you might think that change is small, it affects your portfolio as a whole and left unchecked, can alter the path of your overall investment portfolio. Over many, or even several years, that can take your portfolio to places you had not intended.
To be clear, I am not suggesting you rebalance your portfolio too regularly as that could have ill effects as well. Most will suggest that you should be rebalancing your portfolio semi-annually at most or more likely on an annual basis. Especially for stock investments held outside your 401k, annual rebalancing will have the added benefit of keeping costs lower. Think of rebalancing your portfolio as a tune up that will better prepare your investments to grow over the long haul.
Do you like rebalancing your portfolio annually, or is it something you get to when you can?
Photo courtesy of: Claudio Jule
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