Everyone loves a winner. If an investment is successful, most people naturally want to stick with it. But is that the best approach?
It may sound counter-intuitive, but it may be possible to have too much of a good thing. Over time, the performance of different investments can shift a portfolio’s intent as well as its risk profile. It’s a phenomenon sometimes referred to as “risk creep,” and it happens when a portfolio’s risk profile shifts over time.
Balancing. When deciding how to allocate investments, many start by taking into account their time horizon, risk tolerance, and specific goals. Next, individual investments are selected that pursue the overall objective. If all the investments selected had the same return, that balance – that allocation – would remain steady for a period of time. But if the investments have varying returns, over time, the portfolio may bear little resemblance to its original allocation.
How Re-balancing Works. Re-balancing is the process of restoring a portfolio to its original risk profile. There are two ways to re-balance a portfolio.
The first is to use new money. When adding money to a portfolio, allocate these new funds to those assets or asset classes that have fallen.1
The second way of re-balancing is to sell enough of the “winners” to buy more under-performing assets. Ironically, this type of re-balancing actually forces you to buy low and sell high.
As you consider the pros and cons of re-balancing, here are a couple of key concepts to consider. First, asset allocation is an investment principle designed to manage risk. It does not guarantee against investment losses. Second, the process of re-balancing may create a taxable event. And the information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult a professional with legal or tax expertise regarding your situation.
Periodically re-balancing your portfolio to match your desired risk tolerance is a sound practice regardless of the market conditions. One approach is to set a specific time each year to schedule an appointment to review your portfolio and determine if adjustments are appropriate.
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