Your best financial friend
Manage a Portfolio
Rebalancing
As your investments grow or decline, your asset allocation will drift from its original allocation. You chose the original allocation based on your timeline, risk tolerance, and goal, so you want to return it to the original plan. Rebalancing your portfolio consists of selling what has grown too much and buying what has declined. The beauty of this process is that it forces you to buy low and sell high.
The idea of buy low, sell high is a commonly accepted adage, but its execution is psychologically challenging in practice. No one wants to sell a successful fund to buy a fund that feels like a failure.
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Rebalancing helps you focus not on how well or poorly a fund is doing but on getting your portfolio back in balance. This also helps reduce the risk of your portfolio becoming overweight or underweight in any specific investment. Remember, you made this particular plan for a reason, and you are sticking with it. You should rebalance your portfolio at least once a year, but not more than once a quarter.
The Portfolio Rebalancing Calculator and the Portfolio Rebalancing Journal make rebalancing your portfolio a simple process. After entering your total portfolio balance, the balance of the fund or ETF that needs to be rebalanced, and your desired allocation, the calculator will tell you the target dollar amount of your desired allocation and the amount you need to buy or sell to get to this value.
You can enter this information for each investment in the Portfolio Rebalancing Journal to easily reference when you are on your brokerage website executing trades.
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Let's take a look at how to use the calculator. Say you have $30,000 in an S&P 500 index fund and you want it to be 25% of your total portfolio which has a balance of $100,000. You would enter $100,000 as your total portfolio balance and $30,000 as the balance of the investment to be rebalanced. The target percentage would be .25. The calculator will tell you your target balance is $25,000 and tell you to sell $5000 to get to the target balance.
You can read more about how to rebalance a portfolio in our blog. You can also read more about the process of buying and selling investments. If rebalancing still makes you dizzy, you may want to consider a target date fund, a robo-advisor, or a financial planner.
Portfolio Rebalancing
Calculator
Taxes
If you are investing in a tax-advantaged account, you do not need to worry about taxes until you withdraw money. The withdrawal is taxed at income tax rates unless the money is held in a Roth account, at which point it is not taxed when you withdraw.
If you are investing in a taxable brokerage account, you will need to pay capital gains taxes on your profits when you sell your funds. Rebalancing or withdrawing money are both processes that may cause you to sell funds. Short-term capital gains are paid when you hold the fund for less than a year and are the same rate as income taxes. Long-term capital gains are paid when you own the fund for longer than a year and are generally lower than short-term capital gains rates. You will also need to pay taxes on dividends, although some are taxed as income while some are taxed as capital gains.
You can offset capital gains with tax loss harvesting, which reduces your tax liability. Tax loss harvesting is when you intentionally sell a fund at a loss, offsetting your gains. Be aware of the wash-sale rule that does not allow the tax write-off if you reinvest the loss funds into funds that are too similar to the original loss fund. Tax loss harvesting is only advantageous in a taxable account.
Because they generate dividends, you may want to consider holding Real Estate Investment Trusts (REITs) and bonds in tax-advantaged accounts rather than taxable accounts. When investing in a taxable account, remember that ETFs are slightly more tax efficient than index funds. A tax professional can help you determine the best strategy for your specific situation.
Robo-Advisors
Robo-advisors are investment platforms controlled by algorithms. There is often, but not always, a small fee associated with using a robo-advisor. You can compare different robo-advisors here.
Robo-advisors can help you decide on asset allocation and automatically rebalance your portfolio. Most robo-advisors allow you to choose a risk tolerance-based portfolio (aggressive, moderate, conservative) or specific themes (environmentally conscious, technology innovations).
A robo-advisor can be a compromise between the cheaper cost of self-directed investing and the cost of paying a financial advisor. It can also help take the emotion out of investing because it will automatically rebalance portfolios and not react with emotion based on market activity. The disadvantage of a robo-advisor is that it does not provide you with the same level of personalization and insight as a human financial advisor.
Financial Planners
A financial planner is a highly trained professional that analyzes your situation and recommends a personalized financial plan. Financial planners may also be called investment advisors, financial advisors, or wealth managers. There are a few things I would personally consider when searching for a financial planner.
Look for a fee-only (not fee-based) financial planner. This means you will have to pay them to advise you, although there is often a free consultation. It is a good idea to ask any financial planner how they are paid. If a planner tells you they are free or fee-based, they will likely be paid by recommending products on which they earn a commission, such as whole life insurance with hidden fees or expensive mutual funds that may have load fees. Make sure the planner is a fiduciary, which means they must offer advice in your best interest. You can search for one on XY Planning Network, Fee Only Network, Advice-Only Network, or Nectarine.
Certified financial planners (CFP) have passed an exam covering a wide range of financial planning topics and completed a certain number of hours working as a financial planner. While it is not required that your financial planner be a CFP, the credential can help you find someone who has demonstrated they are qualified.
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Financial planners charge by the hour, the project, monthly or annual subscription, or as a percentage of assets under management. Be aware of assets-under-management (AUM) advisory fees ranging from 0.5% to 2%. It may seem like a small fee but will cost you a significant amount of money over your investing lifetime.
The benefit of a financial planner is that they can look at your specific situation - household income and expenses, risk tolerance, insurance needs, student loans, or mortgage - and create a plan that considers all of your variables. As you enter retirement, they can provide helpful tax-planning strategies and tell you the optimum time to convert or withdraw money. They can point out blind spots in your financial vision and provide strategies to save you money in the long run.
Empower
Perhaps you are not quite ready for a financial planner, but you want an in-depth portfolio analysis. Empower, formerly called Personal Capital, is a great free tool for analyzing your fees, diversification, asset allocation, and risk. After linking your accounts, you can find these features under "Investment Checkup" and "Holdings & Allocations" on the menu. The app can provide model portfolio allocations based on risk tolerance and age. The desktop version includes an efficient frontier analysis to reduce risk and improve returns.
It also has a great retirement projection tool that I will detail on the next page. You will likely be contacted to schedule a consultation with one of Empower's financial planners, but there is no obligation to do so to use the app. I genuinely love this app and use it regularly.
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Next, let's take a look at how deal with a stock market crash.