Working with your investment advisor to keep your asset allocation on track to meet your goals is as important as setting it up in the first place. There are several tactics advisors use when shifting an allocation to ensure that your portfolio performs smoothly and provides ongoing value. There are also tactics to deploy when you are adding investment funds to your portfolio, and finally, it may even be possible to extract value from underperforming investments.
What we’ll cover: Portfolio rebalancing, dollar cost averaging and tax loss harvesting.
Rebalancing to Keep Your Strategy Intact
Portfolio rebalancing is the process of ensuring that all investments in the portfolio maintain their appropriate weight, based on the target asset allocation. As the value of investments increases or decreases, they may get out of sync with the target asset allocation, which will throw off the risk profile of the portfolio. To correct this, investments that have increased in value are sold until the correct weight is reached, and investments that have declined in value are purchased to make up the weighting.
Timing Your Rebalance
When markets are stable, many investors use time as a rule of thumb – rebalancing a strategic asset allocation annually, and a tactical asset allocation quarterly. Strategic just means the overall asset classes you are invested in long-term, and tactical means the shifts within those asset classes that can change based on short-term market conditions. When prices move more quickly in both directions, rebalancing an entire portfolio around a time schedule can result in missing return opportunities or worse, buying into a decline on individual investments.
Setting Tolerance Levels
A more flexible approach is to determine a preferred weighting for a given investment and rebalance whenever the investment is over- or underweight by a pre-set amount. Because each investment is considered separately, only an out- or underperformance will trigger a reallocation. If the entire portfolio increases, no rebalance would occur. This type of tolerance scheme can be enacted either at the strategic or tactical asset allocation level.
Increasing Your Investment – Dollar Cost Averaging
If your portfolio rebalance has resulted in a larger than usual cash balance, or if you have a lump sum to invest from an asset sale or annual bonus, it can make sense to set up a rule that will govern the timeframe over which you invest, and will avoid any attempts to time the market.
This is called “dollar-cost averaging”, and the implementation is simple: the amount to be invested is divided over a specific period of time and invested in equal amounts until the allocation is complete. Whether the stock is up or down on the allotted day, the dollar amount does not vary but the number of shares may, due to share price fluctuations. This may result in reducing the cost basis of an investment, as compared to investing all at once, or attempting to “buy on the dip”. Alternatively, you would be buying less when the investments are too expensive.
Tax-Loss Harvesting: Even Underperformers Can Contribute
If you find your portfolio underperforming, even after rebalancing, securities that have experienced a drop in value may still help contribute to your overall financial situation. They do this by offsetting taxes on both gains and income. Selling a security that has lost value and replacing it with a similar one to maintain an asset allocation is called “tax loss harvesting” – because realizing the loss means it can be claimed as a capital loss and directly applied to a capital gain.
Bottom Line
Investing isn’t just a “one and done.” Shifting your asset allocation and deploying tax-loss harvesting are just some of the ways your financial advisor works to keep your portfolio on track, and keep you updated on what needs to be done and when.
Please contact your financial advisor to learn more about strategies for shifting an asset allocation.
