The Anatomy of Rebalancing

Two of the most important times to rebalance your portfolio are when the stock market has been consistently down and, conversely, when the stock market has been consistently up. In both cases, different parts of your psychological makeup – head, heart and gut – may present significant obstacles when it comes to reaching positive financial decisions.

Since the market has been experiencing some pretty good returns lately, I thought now would be an excellent  time to revisit why maintaining your investment plan in the good times, as well as the bad, is necessary.

Remember, the whole concept behind rebalancing your portfolio at least annually is to maintain the asset allocation that gives you the best chance of attaining your goals while taking the least amount of risk possible. If you don’t take your gains off the table, you’re taking more risk than you need. Taking more risk may not be in your best interest.

When stocks are going up, you may need to sell your best performers and buy the ones on the other end of the spectrum. Sound counterintuitive? Your brain can turn into a major troublemaker when it comes to rebalancing your portfolio. It can be difficult to wrap your head around having to:

  • Give up future gains on the well-performing assets you may need to sell during the rebalancing process.
  • And then, on top of that, pay taxes on the proceeds from the sale.

However, both of these seemingly negative occurrences can have positive consequences for your portfolio as a whole.

In terms of future gains, you’re not selling your entire position, just the gains you’ve made. You’ll continue to experience any growth on what you still hold. Back in my days B.C. – or before children – I played blackjack from time to time. When I sat down at the table, the chips from every hand I won went right into my pocket. Only my original bet stayed in play. I still had my money in the game, but I had the house money safely in my pocket. I knew I wouldn’t win every hand, which made it very clear to me that I shouldn’t just let my money ride until I lost it. What do the equity markets have in common with blackjack? You aren’t always going to win. So why would you leave your gains invested in the market if at some point they could just go away? The correct answer is: You wouldn’t.

As for paying taxes, it helps to consider them from a somewhat different angle. Suppose you own a fund for which you originally paid $8,000, and it’s now worth $10,000. The wrong line of thinking is: “Darn, I’ll have to pay Uncle Sam 15 percent on my capital gain of $2,000. That’s $300!” The right way to think about it is: “At the end of the day, I’ll have $1,700 more in my pocket than I did when I started.” Ask yourself this: If I gave you $2,000 for no reason, would you accept it, even if it meant you had to give Uncle Sam $300? I think most everyone would answer “yes” to that one.

As an investor, once you’ve put the snap conclusions from your head into perspective, the only things left to address are the reactions to rebalancing in an up market from your heart and your gut. If you don’t want to sell a position because of some emotional tie you have to it, then you need to ask yourself if that position should be included as part of your plan. Keep in mind that the only assets you should have working together toward a common goal are the ones you intend to actually use to meet that goal. In other words, if you’re not going to sell it, you shouldn’t be counting it.

For instance, perhaps your great-grandfather bought 10 shares of his father’s company. Upon his death, he passed it to your grandfather, who in turn passed it to your father. Then it came to you. Your plan is to keep the tradition going and pass those shares to the next generation. Because it’s not an asset you would consider selling unless you absolutely had to, it should not be included as part of your investment plan.

That leaves just your gut to deal with. Your gut has a tendency is to tell you, that no matter what you do, you’re making the wrong decision. If you sell equities, they’re going to continue to increase in value. If you don’t sell equities, they’ll drop in value. Constantly presenting yourself this lose/lose situation can lead to a situation where you take no action at all. But no action actually is a decision. It’s a decision not to rebalance. The best way to overcome your gut is to ask yourself which outcome is preferable. Selling an asset and missing out on future gains or holding that asset and watching all your gains go away.

You, understandably, want to make the smartest and best decisions in life. Just remember that your head, heart and gut may appear to be working against you when it comes to rebalancing your investments.


The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2014, The BAM ALLIANCE

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Brad Jenkins, CFP®, ChFC®, CLU®

Brad Jenkins, wealth advisor at Buckingham Strategic Wealth, has helped his clients achieve their financial goals by concentrating on the big picture and applying a comprehensive approach to wealth management. He has demonstrated proficiency in the areas of insurance and risk management, employee benefits, investments, income tax, retirement and estate planning.

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