It’s easy and important to rebalance every now and again, but don’t do it too often. Be mindful of your tolerance for risk, tax position and investment time horizon.
Getting out — and in to– balance
Many financial advisers are paid thousands of bucks each year just to click a button in their client’s investment portfolio.
“Click”.
Money.
What they’re doing is called ‘rebalancing’ and it’s exactly what it sounds like.
As you may know from Rask’s ETF investor’s course, over very long periods the share market tends to grow faster than the bond market or cash (e.g. term deposits). I’m talking about 10+ years or longer.
What this means is after many years (10+) the money you have invested in, for example, an Australian shares ETF will become a much larger part of your portfolio than the money you invest in a cash or bond ETF.
For example, you might start with 50% in two ETFs, a bond ETF and an Australian shares ETF. Over 10 years, you can reasonably expect the shares ETF to grow faster than the bond ETF. Meaning, after 10 years, the shares ETF will become a larger part of your portfolio.
So how do you stop 1 or 2 ETFs from becoming too much of your portfolio? For example, if you want to invest 70% in share ETFs and other riskier investments and just 30% in less risky ETFs, how do you keep it in balance?
The answer: rebalancing.
In my opinion, choosing when you rebalance is a personal choice. Like going to the gym or working out, you should do it regularly. But you might not need to go as much as I do.
When you choose to rebalance your portfolio might be determined by:
- Your tolerance for risk
- Your tax position. Every time you sell a share or ETF you may need to pay capital gains tax (CGT)
- The performance of your investments
For example, you may have read the Rask ETF Strategy and my discussion on knowing your level of risk and said to yourself: “Ok, I want 70% of my money in shares and 30% in less risky investments like term deposits or bonds.”
After a few years, you might look down at your portfolio and say: “Hmm… my share ETFs have grown to 75% or 80% of my portfolio. That’s too much risk for me. I think it’s time I rebalance.”
Another way you might ready yourself for a rebalance is by setting a yearly calendar reminder to automatically notify you that it’s time to sit down and rebalance your shares-to-term-deposits-or-bond ETF ratio.
How rebalancing works
Let’s take a simple portfolio of 3 ETFs. Here’s what your portfolio might look like before and after a rebalance.
| Before rebalance ($) | Before rebalance (%) | After rebalance ($) | After rebalance (%) | |
| Australian shares ETF | $25,000 | 41.67% | $21,000 | 35% |
| International shares ETF | $20,000 | 33.33% | $21,000 | 35% |
| Bond ETF | $15,000 | 25.00% | $18,000 | 30% |
| Total | $60,000 | 100% | $60,000 | 100% |
As you can see in the example portfolio above, the portfolio was ‘rebalanced’ to the 70/30 target. Given that two of the portfolio’s positions are investing in share ETFs, it would mean 70% in shares and 30% in a bond ETF after the rebalance.
It’s that simple!
Taxes & other things to consider when you rebalance
You should consider your risk tolerance, timeline to invest and the tax you’ll pay if you sell (see our tutorial “Do I Pay Tax On My ETF?” in our Rask Education ETF course).
Keep in mind, you don’t have to get your portfolio into balance overnight.
Instead of selling an ETF and incurring a capital gain, you might simply choose to invest more money in one part of your portfolio to get it back into balance.
For example, if you want more percentage in a bond ETF, you could consider investing more of your monthly income over the next six months into the bond ETF instead of selling your share ETFs.
Summary
In reality, rebalancing a portfolio comes back to what you’re comfortable with. For example, I rarely — if ever — rebalance my portfolio for the sake of rebalancing. However, I’m me and you are… you!
Set a target and do what makes you comfortable.
