You have a well-balanced portfolio you love – then you get back your year-end statement and notice that some of your assets are out-of-whack. There’s no need to panic; that’s what rebalancing is for. Rebalancing your portfolio involves buying and selling assets to get a good allocation. The process isn’t always cut-and-dry, though. Here are common mistakes investors make. By following these, you can hopefully avoid them yourself.
Making Big Moves With Little Experience
Before you start moving anything around, ask yourself if you truly feel like you have enough experience to be doing this on your own? If you don’t feel 100% confident in your knowledge, then it may be best to enlist the help of an expert who can give you some advice. Too often, people start shuffling around their investments, not understanding the ramifications of their efforts. Before you know it, you could wind up with a mix of investments that are doing more harm to your portfolio than good.
If this is your first time rebalancing your portfolio and you really want to learn, that’s great! But, stick to small changes and ask someone who knows what they’re doing to at least give you some pointers. As you gain more experience with rebalancing and can see the effects of your changes, you’ll begin to understand the process more.
One thing to consider is that most of the best robo-advisors will all have a feature for automatically rebalancing a portfolio. If you use a robo-advisor like Betterment or Wealthfront, then you can use this feature as a guide and training tool.
Getting Too Attached
If you’ve had your current portfolio for a while, you may become attached to your investments. It happens. You’ve put your money to work and feel proud when things are going well. That makes you want to stick it out even when they begin underperforming. But, if you don’t let go of anything, you can’t expect to have a winning portfolio.
Think of your investments in the bigger picture, rather than seeing them as individuals. Clean out the closet, so to speak, by getting rid of a few investments that aren’t working for you. The point is to have a solid return, rather than hope that each of your investments has success. If something continuously isn’t working to boost your portfolio, it’s time to part with it.
Looking for Winners
With that being said, you can’t expect to have a portfolio full of winning investments. Looking only for winning assets to invest in may leave your portfolio very unbalanced – the exact opposite of what you’re shooting for. If an asset has been performing extremely well for the last year, that’s great, but you shouldn’t expect past performance to dictate future results.
If you add in more of a winning investment, like stocks, while getting rid of lower-performing bonds, you could wind up with a portfolio with a lot of one investment and not enough of another. The key is to have several types of investments to minimize your risk, also known as diversifying your portfolio. If you have several stocks that are doing well, but your bonds are tanking, you should consider letting a few of the lowest-performing bonds go while adding in a few more different bonds for which you have high hopes. This will help keep a healthy balance of each.
Not Paying Attention to Overlaps
In addition to too much of one type of asset and not enough of another, your portfolio may wind up with overlapping assets. This usually happens in the case of mutual funds or exchange-traded funds (EFTs), which have underlying investments. Investors may look at the mutual fund as a whole and ignore the individual investments that make up the mutual fund. They see mutual funds performing well and add more to their portfolio, not paying attention to their makeup.
When this happens, it can have a serious impact on your diversification. Your mutual funds or EFTs that overlap will have the same reaction to market fluctuations, which could pose a high risk of loss when they underperform.
Failing to Take Taxes Into Account
One of the biggest and costliest mistakes investors make when rebalancing their portfolios is forgetting about the tax ramifications. Anytime you sell investments that have been profitable, you’re increasing how much you might owe in capital gains.
The best way to avoid a sky-high tax bill is to focus on underperforming assets. Add in new investments to replace the ones that aren’t profitable. Then try to wait as long as possible before cashing out your winners. There is no point in getting stuck with short-term capital gains when you don’t need to.
Rebalancing to Create a Winning Portfolio
Rebalancing your investment portfolio may seem overwhelming, but it doesn’t have to be. When you know the most common mistakes to avoid, you’ll set yourself up for creating a well-balanced portfolio that leads to profitability. If you feel uncomfortable doing it yourself, you should consult an expert to guide you with what’s best for you. Start off making small moves to gain experience and always stay one step ahead of yourself by taking into consideration the potential implications.
