No matter what type of investor you are, keeping your portfolio in balance is essential. Having a balanced portfolio ensures your asset allocation is still on track for your investment goals. If you're more of a hands-off investor, then automatic rebalancing is an excellent feature to have because it does the work for you.
This article will discuss what automatic rebalancing is, how it works, the benefits, and tips for setting up. That way, you can take full advantage of having a diversified investment portfolio for your goals.
What is automatic rebalancing?
Automatic rebalancing is the process of rebalancing your portfolio when it gets out of alignment. Since the market fluctuates, it can cause your asset allocation to become out of balance.
For example, if you have a portfolio that’s 50/50 stocks and bonds and the stock market crashes, suddenly, your portfolio will be much heavier in conservative bonds than stocks. If you left it that way, you wouldn’t have the returns you anticipated at the end of your timeline because bonds are more conservative.
With an auto rebalance feature, you’ll get your portfolio back to the appropriate allocation by selling the securities you have too much of and buying more of the securities your portfolio lacks. So your portfolio will be realigned to your desired asset allocation automatically!
Robo-advisors commonly offer an automatic rebalance feature, taking the pressure off you and helping you sleep better at night.
How does automatic rebalancing work?
Automatic rebalancing occurs automatically. As soon as your portfolio’s allocation is off from your intended target, your brokerage's algorithm or Robo-advisor jumps in and fixes it.
Most brokerages and Robo-advisors provide you with options; you can choose ongoing rebalancing or rebalancing in specific intervals, such as monthly, quarterly, or annually.
Based on your selection, they will sell off securities you have too much of and use the proceeds from the sale to buy securities you’re short on. This should bring your accounts back into alignment according to your intended allocations.
Benefits of using the auto rebalance feature
Automatic rebalancing provides investors with many benefits, including those discussed below.
Removes the emotional aspect of investing
It’s easy to make emotional decisions that backfire in the end. If the market crashes or a specific stock you hold falls fast, you may think it’s right to dump it and save your money. Sometimes it’s not the best answer, though.
A buy-and-hold strategy often works best, but that’s hard to do when you see your allocations changing so drastically. Rather than reacting emotionally, you can feel at ease knowing the Robo-advisor will reallocate your portfolio accordingly and without emotions playing a role.
Mitigates risk
When you don’t rebalance your portfolio, you’re at the mercy of the market. In other words, the market determines your allocation, which probably isn’t what you want.
A portfolio that never rebalances could take a somewhat aggressive portfolio and make it very aggressive. Alternatively, it could also become not aggressive enough, depending on how the market went and based on your goals. Staying on top of the allocation ensures your portfolio’s risk doesn’t change according to how you set it up.
Reallocates assets based on your goals
When you set up your portfolio, you likely did so with certain guidelines and timelines in place. The allocation should work based on all calculations and circumstances, but again, markets change unpredictably.
If you don’t reallocate your portfolio, there’s no guarantee you’ll reach your goals in the timeline you set. This could cause you unnecessary stress and/or cause you to make irrational investment decisions to make back what you lost.
Balances your portfolio
When you balance your portfolio, you have the allocation you intended. Letting the market dictate your allocation may leave you off balance. What if you aren’t comfortable with the new allocation? It may be too risky or too conservative for your goals and timeline.
Provides dollar-cost averaging
When you have auto rebalance set up, you’ll buy assets at their current price, whatever that price is when you need to rebalance. You aren’t waiting for the best price but rather investing in different intervals to make the most of your portfolio. This dollar-cost averaging format gives you access to good prices and sometimes bad prices, but they average out in the end.
Offers investment flexibility
Automatically rebalanced portfolios are flexible too. You aren’t stuck only making allocation changes when your portfolio is ‘off.’ You can buy and sell in between the automatic rebalance occurrences too.
If you want to invest in a particular asset or to get out of one, you are free to do so. If it changes your allocation, your portfolio may be rebalanced slightly, but you can still make the changes you want.
Is great for a hands-off approach
Handling your own asset allocation can be time-consuming and overwhelming. Going back to the emotional aspect of investing, you could make rash decisions when calculating your own asset allocation and jump ship or jump in headfirst when you shouldn’t be.
Automatic rebalancing provides a hands-off approach so you can rest assured your portfolio is in good hands, but you don’t have to do the work to get it there.
Example of how automatic rebalancing works
To help visualize the process, here is an example of how an auto rebalance process would work:
John created a retirement investment portfolio that included 35% stocks, 25% bonds, and 40% other investments. After a couple of months, the market had some turbulence, and John’s portfolio ended up at 50% stocks, 10% bonds, and 40% other investments.
This is riskier than John wanted and has put his goals at risk. With automatic rebalancing, though, his Robo-advisor sold the excessive stocks, reinvested the money in bonds, and brought John’s portfolio back to the allocation he was comfortable having. So you can see how beneficial it is to have an auto rebalance feature!
Key tips for automatic rebalancing
So are you ready to give it a try? Here are the tips you should keep in mind if you’d like to auto rebalance your portfolio.
1. Look for brokerages and Robo-advisors that offer automatic rebalancing
Not every broker or advisor offers automatic rebalancing. You’ll have the most success with Robo-advisors, for example, Betterment, Wealthfront, and SoFi. They all offer automatic rebalancing.
Traditional brokerages like Vanguard, Fidelity, Charles Schwab, and more also offer automatic rebalancing when you invest in some of their funds.
2. Leverage auto rebalancing in retirement accounts where there are tax implications for doing so
If you’re rebalancing a retirement portfolio (the most common), you won’t incur tax liabilities when you sell assets within the account. However, you also can’t write off any losses that occur if you sell investments at a loss.
Having no tax implications on a retirement account ensures that you can utilize auto rebalancing to its full potential. You can always set up diversification and asset allocation based on your age and retirement plans. A classic example of this is with a target-date retirement fund.
3. Use automatic rebalancing to take advantage of market downturns by buying assets at a lower price
If the market falls and your allocation dips, you can take advantage of lower prices with auto rebalancing. This means you can get more bang for your buck. For instance, you could exchange some of your bond funds for stock funds.
Since you don’t have to do the calculations, you reap the rewards without doing the work. An auto rebalancing feature will move all of your money around for you.
4. Remember to choose your auto rebalance parameters when you set up your account
Most Robo-advisors allow you to set up the threshold of automatic rebalancing. For example, if you aren’t concerned if the portfolio drifts slightly, you can set the point at which you’d want the portfolio rebalanced.
Many Robo-advisors also allow you to choose the frequency. Some do it automatically, and others will enable you to choose monthly, bi-monthly, semi-annually, or annually.
Make investing easier with automatic rebalancing!
Automatic rebalancing takes the pressure off of you. All you have to do is make regular contributions, and your platform handles the rest. It may sound like the easy way out, but it ensures your portfolio is always on track and it makes efficient, not emotional investment decisions for you.
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