As illustrated in "Comparing Rebalancing Strategies," rebalancing at least annually may be the most effective approach. Adjusting your portfolio more frequently may give you peace of mind—particularly during challenging periods in the market—but there may be drawbacks to too-frequent rebalancing, including the potential for higher trading fees and capital gains taxes that can diminish your portfolio's return. "You should consider rebalancing every year," says Ritter. "Rebalancing too frequently could be counterproductive—and more time consuming than is necessary to achieve the results potential you're looking for."
Once you decide on a regular schedule for rebalancing, consider which of the following strategies you will use:
- Sell investments that are overweight and use the proceeds to boost areas of your portfolio that are underweight.
- Identify the areas of your portfolio that have fallen below your targets and devote new contributions to those asset classes until they reach the percentage you want.
Ritter recommends the first strategy in most cases, noting that it offers the quickest opportunity to bring your portfolio's asset allocation back in line with its targets. "Directing new contributions to underweighted areas can help," he says. "At the same time, it's better to correct overexposure to risk quickly rather than gradually."
Remember to consider all investments related to the same goal—for example, IRAs held with different providers—rather than just a single account, when realigning your asset allocation. You can do the bulk of your rebalancing work with nothing more than a calculator. Tools such as T. Rowe Price's Portfolio Manager and Morningstar's Instant X-Ray® also can be helpful, providing you with a better understanding of how your portfolio is divided among key asset classes and sub-asset classes. With a few mouse clicks, you can easily analyze holdings across several different accounts and see where overweights and underweights exist.
Charts are for illustrative purposes only and do not represent the performance of any particular investment. Past
performance cannot guarantee future results.
* Stock market returns are based on the S&P 500 Index; bond returns, on U.S. intermediate-term government bonds; short-term investment returns, on U.S. 30-day Treasury bills.
You might also consider outsourcing the job of keeping your asset allocation in line by using an account that offers an automatic rebalancing service. Many IRA providers offer this service for their customers. Certain investments—such as the T. Rowe Price Asset Allocation funds—are designed to rebalance their portfolios automatically. "For some investors, having a service or investment professional do the work of rebalancing can make a big difference," says Ritter. "And it means less work for you."
You can't control the daily—or even long-term—ups and downs in the financial markets. But you can take steps to keep your investment strategy on track as markets move over time. Rebalancing is essential among these strategies; it's a valuable action that will keep your asset allocation in line with your goals. Take the time to review your target asset allocation and your portfolio's current allocation, if you haven't done so in the past year, and then set an annual date on your calendar for rebalancing.
The Advantage of Asset Allocation Funds
Two varieties are typically available:
Target-date funds, such as the T. Rowe Price Retirement Funds, are designed for investors preparing for a goal—typically retirement or college—that begins on a particular date. The funds provide a diversified mix of asset classes tailored to a specific time horizon. They gradually shift their allocations over time to remain appropriately invested as the goal draws near.
Target-risk funds, such as the T. Rowe Price Personal Strategy Funds and T. Rowe Price Spectrum Funds, provide a specific mix of asset classes designed around a particular level of risk; as a result, they maintain a more static asset allocation. For example, the Spectrum Growth Fund holds close to 100% of its assets in stocks, while the Spectrum Income Fund typically holds approximately 85% in bonds and short-term investments, with 15% in stocks. Unlike target-date funds, the mix in these funds stays essentially unchanged over time.
Automatic IRA Rebalancing Service
T. Rowe Price offers an automatic IRA Rebalancing Service to help you maintain a consistent allocation among your T. Rowe Price investmentsregardless of market fluctuations. To qualify for this free service, all you need is an IRA mutual fund balance of $10,000 or more at T. Rowe Price.
The principal value of the Retirement Funds is not guaranteed at any time, including at or after the target date, which is the approximate date when investors turn age 65. The funds invest in a broad range of underlying mutual funds that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. The funds emphasize potential capital appreciation during the early phases of retirement asset accumulation, balance the need for appreciation with the need for income as retirement approaches, and focus more on income and principal stability during retirement. The funds maintain a substantial allocation to equities both prior to and after the target date, which can result in greater volatility.