Matt Schmitt, CFA® Senior Vice President, Director of Equity Strategy
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Key Highlights
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Asset allocation in a portfolio is constructed based on an investor’s goals, risk tolerance and time horizon. By strategically distributing investments across various asset classes, investors can chart a course towards their long-term financial goals. However, asset weightings in a portfolio can shift over time due to the natural movement of the markets.
Portfolio rebalancing is the process of readjusting a portfolio’s asset allocation back on course to its original target objective or to align the portfolio with your current investment objectives.
Portfolio rebalancing can also help manage portfolio risk. For example, if a portfolio becomes heavily concentrated in assets that have performed well over time, the investor could be creating greater exposure for themselves in the assets than was originally intended. If market conditions were to change and those assets did not continue to perform the way they did in the past, it may make sense to sell some of those concentrated positions and redirect the proceeds to other investment opportunities that better meet the objectives of the investment strategy.
At Commerce Trust, our financial planning and portfolio management officers work together as a team to ensure our clients’ investment portfolios are appropriately allocated to deliver a balanced risk and return profile that aligns with their unique, comprehensive wealth plans. This requires taking an aggregate view of a client’s entire investment picture, not just one account.
All investment accounts should be considered when initiating a rebalancing strategy. For example, retirement vehicles such as IRAs or 401(k) accounts could be overlooked because those investments may not be actively monitored on a consistent basis though the balances of those accounts may be significant. With many 401(k) plans featuring automatic increases on contributions, 401(k) account holders may want to review their contribution selections over time to ensure these retirement accounts continue to be aligned with your long-term asset allocation plan.
Rebalancing could provide tax benefits
Portfolio rebalancing could also help provide investors some tax relief on taxable investment accounts. Securities may become highly appreciated over time, presenting a significant capital gains tax hit when finally sold. That capital gains cost could be spread over time with rebalancing. An investor may also consider a tax-loss harvesting approach to potentially offset realized investment losses with realized gains.
Another strategy to minimize tax impacts from an overweight position in highly appreciated securities could be to gift a portion of the position to a qualified charity. This would reduce a concentrated portfolio position while possibly offsetting a large capital gains tax. Investors should talk with a tax professional about strategies around the charitable gifting of appreciated securities.
When should you rebalance your portfolio?
Because the timing of when you rebalance your portfolio is important to consider, how do you know when to review your portfolio for rebalancing?
Among the reasons when rebalancing may make sense are periods of market volatility or when you are approaching major life events such as entering into pre-retirement. Perhaps the portfolio hasn’t been rebalanced for some time. Some investors opt for a rebalancing schedule based on when assets within the portfolio shift by a predetermined amount. Others may prefer a calendar approach to rebalancing when it’s time for other financial-related tasks like preparing for taxes.
Commerce Trust takes a more consultative approach to this question. Our client teams monitor portfolio movements in relation to market conditions on an ongoing basis and keep clients apprised of portfolio activity. This ongoing client dialogue allows for more timely decision-making on portfolio health like rebalancing or other portfolio maintenance activity.
Because portfolio rebalancing is a key component of an investment strategy, the case for periodic rebalancing over time centers on the benefits of ensuring your portfolio maintains a balanced risk and return profile aligned with your current portfolio strategy, allowing you to stay on course to meeting your long-term financial goals.
Contact your Commerce Trust team to discuss the benefits of portfolio rebalancing as part of a comprehensive private wealth management plan.
How a balanced portfolio can drift over time
Natural movement of a 60% stocks/40% bonds portfolio without rebalancing, as of September 30, 2024
Chart reflect combinations resulting from the monthly performance of the S&P 500 index and the Bloomberg U.S. Aggregate Bond Index from February 28, 2009 (the trough point of the Great Financial Crisis) through September 30, 2024. For illustrative purposes only. Past performance is not an indicator of future results, and individual investors returns may vary. Source: Commerce Trust, Morningstar
The Chartered Financial Analyst® (CFA®) Charter is a designation granted by CFA Institute to individuals who have satisfied certain requirements, including completion of the CFA Program, and required years of acceptable work experience. Registered marks are the property of CFA Institute.
Certified Financial Planner Board of Standards. Inc. (CFP Board) owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the United States, which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.
Past performance is no guarantee of future results, and the opinions and other information in the commentary are as of November 12, 2024. This summary is intended to provide general information only and is reflective of the opinions of Commerce Trust. This material is not a recommendation of any particular security, is not based on any particular financial situation or need and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional.
Diversification does not guarantee a profit or protect against all risk. Commerce Trust does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product and specific financial situation. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Commerce Trust is a division of Commerce Bank.
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