By Dr. Nicholas E. Michels

Why Rebalance?

Manage Risk

The process behind rebalancing helps manage risk in two ways. (1) It maintains your original investment objective, and (2) it maintains your risk profile. According to a historical analysis of accounts during market turmoil conducted by Morningstar, portfolios that WEREN’T rebalanced in the middle of a tumultuous market saw longer recovery periods. 

Secure Financial Gains Already Earned

This can go against some natural instincts when it comes to investing. The discipline behind rebalancing forces investors to sell when their investments are high, and buy while others are low. This is exactly what makes investing successful. Clients may ask, “Why should I sell my winners?” Well, in an unpredictable market, no one knows when winners may not be valued as highly as they are when you rebalance.

Harvest Losses in Taxable Accounts

Essentially, you want to create tax losses by selling losing positions. However, in order for investors to net their losses against their gains, they cannot trade back into the losing positions for 30 days. What you can do in the meantime is buy an alternative investment. For example, an exchange-traded or index fund, allowing you to continue to be in the markets. Then, on day 31, sell the alternative investment and move back to your original position. Assuming it is still the highest-conviction holding for that part of the allocation.

Removing Emotional Elements Behind Investing

During an unpredictable market, emotional selling is a natural impulse. However, if we sell while we are down, we are locking in losses rather than gains, which may not be desirable unless you wish to harvest losses. Rebalancing enforces structure and discipline in the processes of investing and asset allocation. By providing, enforcing structure, and discipline, we are lessening the chances of acting off of emotional impulses. A consistent, well-documented strategy for rebalancing should help protect investors against a hasty decision to change a long-term investment strategy.

“Successful investing takes time, discipline, and patience. No matter how great the talent or effort, some  things just take time.” – Warren Buffett