The recent pandemic has significantly affected long-term investment accounts, leaving many portfolios in need of attention. Rebalancing is essential to regain balance in your investments.

If your investment accounts were likened to hairstyles, they'd be in disarray—think unruly bobs for IRAs, uneven bangs for 401(k)s, and patchy buzz cuts for brokerage accounts. Market fluctuations can create these imbalances, and it's crucial to address them.

While the downturn caused by the pandemic may eventually correct itself, it can leave your portfolio lopsided. Rebalancing is the key to restoring the right mix of stocks, bonds, and cash in your investments.

Understanding Portfolio Rebalancing

Portfolio rebalancing involves buying and selling assets to maintain your desired investment mix. For example, if you aim for a 75% allocation in stocks and 25% in bonds, a market dip could alter that balance to 50% stocks and 50% bonds. To realign your portfolio, you can either sell some bond investments to reinvest in stocks or inject new funds into stocks. We'll explore various rebalancing strategies soon.

Even without significant market events, your asset allocation can drift over time. Most investors only need to rebalance once or twice a year to keep their portfolio aligned with their goals.

Not every retirement account needs rebalancing. If you're using a target-date fund or an automated investment service, adjustments are typically managed for you, ensuring your portfolio maintains the desired balance.

If you actively choose your investments and hold a variety of assets, here’s how to regain control of your portfolio.

1. Review Your Target Asset Allocation

Your asset allocation reflects your risk tolerance. If you already have a plan, stick to it. It’s important to maintain your stock market exposure, especially with a long-term investing horizon of 10 years or more.

If you haven't established a plan, a common rule of thumb is to subtract your age from 110. This number indicates the percentage of your long-term savings that should be allocated to stocks. The remainder should go toward bonds and cash.

Within the equity portion, diversify across sectors, regions, and company sizes. For guidance, consider looking at a target-date fund that aligns with your retirement timeline, such as the Fidelity Freedom 2050 fund, which allocates 50% to domestic equities, 39% to international stocks, and 7% to bonds.

2. Assess Your Current Investment Mix

Log into your investment account to view your current asset allocation. Compare this with your target allocation, as it's likely that your stock position is underrepresented due to recent market shifts.

Identifying the main reasons for the imbalance will help you strategize your return to the desired allocation.

3. Make Gradual Adjustments for Balance

Generally, adjustments are recommended when an asset class shifts more than 5%. However, avoid reacting to every market fluctuation, particularly in today's volatile environment. As a market strategist advises, take gradual steps to rebalance: “If you need to make changes, adjust about 25% at a time.” Monitor the results over several weeks before making further adjustments.

Here are a few strategies you can consider for rebalancing:

  • Direct new contributions into underweighted assets to strengthen your positions without selling off other investments.
  • Sell positions that are overweighted and reallocate the proceeds to underweighted investments, though be cautious of realizing losses.
  • If you're retired and withdrawing funds, consider taking from overweighted assets first.

Many 401(k) plans allow for automatic rebalancing. If you haven't rebalanced in the last six months, now's the time, but limit this to twice a year for optimal results.

4. Consider All Your Investment Accounts

Investment accounts can accumulate over time, including 401(k)s, IRAs, and brokerage accounts. Together, they form your overall portfolio, which should be included in your asset allocation strategy.

Your rebalancing approach will depend on factors like account balances and tax implications:

  • If accounts are similar in balance and tax treatment, treat each one as a mini portfolio, applying the same allocation model across them.
  • If one account is concentrated in a specific asset type, you may need to adjust other accounts to maintain overall balance.

Final Thoughts on Portfolio Rebalancing

Finding the right balance between risk and reward is essential. While current market conditions may skew risk perception, remember that corrections are part of the cycle and will eventually subside. Stick with your long-term strategies and asset allocation plans to navigate through these fluctuations successfully.