With Britain moving to leave the European Union, effects of the tumult are sure to show up in your investments, at least for a while.
So should you rebalance your portfolio immediately to take advantage of opportunities?
Rebalancing involves selling a portion of assets that performed well, and buying more of those that fared poorly. The idea is to return to the proportions that reflect your personal needs. A common base case is 30 percent in bonds with the remainder in stocks and other assets.
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So would it pay to reshuffle now? Maybe not. Acting too hastily could be just as harmful to your wealth as never making any changes.
Here are some key things to consider:
Risk tolerance. “The goal of rebalancing is to take stock of your risk tolerances and at the same time keep a steady hand,” says Martin Schulz, managing director of international equities for PNC Capital Advisors. “What you don’t want to do is to get emotional about your changes.”
How much volatility can you deal with? If you don’t want to risk losing a lot, then you’d need to have a lower allocation of stocks than someone who doesn’t mind bigger fluctuations in value.
This tolerance for risk typically changes over time. For instance, those who rely on investments for their retirement income would often have less room taking big losses in the immediate future. That contrasts with most people who are starting out their career. Such individuals, maybe in their 20s, have decades to leave their money invested without worrying about year-to-year fluctuations.
Follow a discipline. “Don’t try to time the market,” says Barry James, president and CIO of James Investment Research and portfolio manager of the James Balanced: Golden Rainbow Fund (ticker: GLRBX).
“You have to follow the discipline, and that means when equities are down you have to put more in,” he says. “That can be the hardest thing to do, emotionally.”
A year-and-a-day. When you rebalance a portfolio it involves making a trade and if the securities you buy and sell are not inside a tax advantaged plan, such as a 401(k) or individual retirement account, there could be immediate tax consequences.
“Give yourself as much leeway as possible to let yourself take long-term gains rather short-term ones,” says Adam Johnson, founder and author of the Bullseye Brief investment newsletter. “The ideal time to rebalance is 366 days,” one day more than a calendar year.
The reason for this is that short-term capital gains tend to be taxed at a much higher percentage than those on long-term gains. But the good news is if you hold a security for a more than a year it will be classified as a long-term gain.
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Lower taxes mean more money left for you to reinvest.
If your investments are solely held in an IRA or 401(k) then this may not be a problem, but consult your tax advisor anyway.
When not to bother. “If portfolio allocations have moved less than 2 percentage points don’t bother changing anything because you’d be creating unnecessary profits for your broker,” Johnson says.
For example, if you had a target allocation to stocks of 60 percent of your overall portfolio, you shouldn’t make any trades to change it when the allocation remains within the range 58-62 percent.
Other professionals have similar although not identical practice. For instance, Rose Swanger, a certified financial planner at Advise Finance in Knoxville, Tennessee, says that the criteria she uses on whether to rebalance is when the asset class as a proportion of the total portfolio moves by between 3 and 5 percentage points, up or down.
Johnson says that such ranges reflect a “margin of error” in measuring how much of each asset is held. Markets move all the time and just because your actual allocation is a percent or two different from your plan is just statistical noise.
The important thing to remember about rebalancing is that it costs time and money. Every sale and purchase of stocks or exchange-traded funds will incur brokers fees. That’s money that could have been left invested to grow over time.
For people who invest only in mutual funds, then trading costs typically don’t matter. Still, tweaking your holdings less than 2 percentage points wastes valuable time.
When to break the rules. While it is good to stand back and let your portfolio grow uninterrupted by trading costs or taxes, there are also times when it is important to act decisively.
Johnson says there will be trades that don’t work out, such as stocks that fall rather than rise. What’s important, as any veteran of financial markets will tell you, is to cut your losses quickly — regardless of commission costs or taxes.
He suggests placing a stop-loss order on stocks at about 10 to 12 percent below the purchase price. “That’s about as much as I’m willing to lose,” he says.
[Read: Crossing the Dividend Divide.]
If the stock is for a smaller company, it will likely be more volatile so Johnson places the stop-loss order at 15 to 20 percent below the price.
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Why It Pays to Be Careful When Rebalancing a Portfolio originally appeared on usnews.com
