Investment Portfolio Rebalancing – The Basics

Most cardiologists will become investors at some point in their lives, whether this begins with savings from a high school summer job, an employer-sponsored retirement plan as an attending, or anywhere in between. When you purchase investments, you are probably aware that the value of these may fluctuate, sometimes significantly. Earlier in the year, we wrote an article about the importance of not making large, emotion-based changes to your investments during periods of market volatility. This article will cover an aspect of investment management in which making adjustments is beneficial, called portfolio rebalancing.

The first term to define is "target allocation," which is the proportion of each asset class an investor is aiming to hold in their portfolio. An asset class is simply a category of investments. Large U.S. company stock falls into one asset class, whereas bonds are a separate asset class with different risk and return characteristics. Why should you hold multiple asset classes? Well, investment choices may be clear in hindsight, but our crystal ball is foggier looking ahead. The technology and real estate bubbles are two examples that have caught investors unaware in the recent past. If your portfolio was overweighted to technology stocks heading into 2000, then you would have seen a substantial decrease in your portfolio's value. It would have been helpful to have other asset classes that did not fall as far as technology stocks to offset some of their losses. Holding investments whose returns are less than perfectly correlated is the essence of asset class diversification. While this does not fully protect against a loss, it can help decrease the severity.

Let's now say it is Jan. 1 and your portfolio is diversified among several asset classes in your desired target allocation. Perfect! Then 12 months go by. Over the year, it is reasonable to expect that some asset classes have performed better than others and some have done worse, skewing your holdings away from their target allocation. Your portfolio is now overweighted in the investment categories that have outperformed and is underweighted in the asset classes that have lagged. It is now time to consider rebalancing your portfolio, which means bringing the overall allocation back into alignment with your target allocation by selling some in the overweighted asset classes to purchase investments in the underweighted asset classes.

U.S. Stock

Int'l Stock









sell $40

buy $40



Let's work through an example to see this in action. We begin with a target allocation of 50 percent U.S. company stock and 50 percent international stock, and invest $100 into investment options representing each of these asset classes. Over the year, the U.S. economy is booming and your $100 investment generates a 60 percent return, ending the year at $160. Unfortunately, international markets had a 20 percent slump and this $100 investment is now down to $80. What we see is that instead of holding your target 50/50 split, your portfolio is now 2/3 in U.S. stock and only 1/3 in international stock. This is fine only as long as the U.S. economy continues to outperform.

However, accurately predicting asset class returns from year to year over an extended period is extremely difficult, if not impossible. Maybe next year international markets take off and the U.S. has a recession. You would not want to be skewed too far toward an asset class that may be ready to underperform. Portfolio rebalancing fixes this situation by selling $40 of U.S. stock (capturing the gain) to then buy $40 of international stocks (buying at a relatively low price), resulting in $120 in each at the end of the year, back at your target 50/50 allocation. Your portfolio is now positioned for whichever asset class performs well or poorly next year.

Please keep in mind this example is for teaching purposes only and the allocation used is not a recommendation. You will want to consider other variables, such as trading costs and the effect of realizing capital gains and losses when investing in a taxable account. Periodically rebalancing your portfolio can help avoid becoming grossly overexposed to an asset class, while redirecting gains to asset classes that may be undervalued after a slow year.

This article was authored by Marshall Weintraub and Michael Merrill, CFP, CLU, ChFC.

Marshall Weintraub & Michael Merrill are financial advisors with the independent financial services firm, Finity Group, LLC. To ask them questions or arrange a consultation, email them at Office Address: 4380 SW Macadam Ave, Suite 245, Portland, OR 97239. Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Finity Group, LLC and Cambridge are not affiliated. Diversification and asset allocation strategies do not assure profit or protect against loss. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.