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What Is Automatic Rebalancing? Auto Rebalancing Explained

Last Updated on August 24, 2023 by Dan Kent

Disclosure: Please note that this article may contain affiliate links which means that – at zero cost to you – I might earn a commission if you sign up or buy through the affiliate link. That said, I never recommend anything I don’t  believe is valuable

As investors seek greater control over their financial goals and portfolios, automatic rebalancing becomes increasingly important.

This strategy allows investors to maintain a preferred portfolio mix, thereby enhancing their ability to diversify assets and achieve the optimal level of risk in their portfolios.

In this article, we will explore the mechanics of auto-rebalancing, its benefits, and how it integrates within robo-advisors, brokerages. and portfolio management tools to maximize ones investment potential.

What is automatic rebalancing?

Automatic rebalancing, commonly known as auto-rebalancing, is the process that adjusts the asset allocation in an investment portfolio to ensure it remains aligned with the investor's target allocation. When a portfolio is left unattended, market fluctuations can cause your holdings to drift from your initially determined investment mix. This drift can over-expose investors to certain assets, thereby increasing their risk.

Auto-rebalancing consistently adjusts the portfolio mix to align with the investor's chosen asset allocation. This rebalancing can be triggered by time (calendar rebalancing), threshold levels (tolerance rebalancing), or a combination of both.

Whether bonds, mutual funds, or stocks, having a balanced portfolio is critical to reducing potential downside and meeting long-term financial goals. With automatic rebalancing, assets in a retirement or investment account can be systematically adjusted to maintain this balance.

The role of robo-advisors and brokerages

Robo-advisors and online brokerages are expanding rapidly in the investment sphere thanks to features like automatic rebalancing. These platforms rebalance investors' portfolios using complex algorithms and pre-set rules. 

This auto-rebalancing feature takes the emotion out of investing, minimizing irrational decisions driven by market fluctuations.

For investor portfolios comprising various asset classes like stocks, bonds, and others, a robo-advisor maintains the desired target asset allocation. Transaction fees are usually incorporated into the robo-advisor's fee, which is, in general, lower than those charged by traditional brokers.

Traditional brokerages also offer services for automatic rebalancing. However, customers must stay proactive and ensure they are enrolled in these services.

The impact of automatic rebalancing on investment performance

Having rebalanced portfolios allows investors to purchase assets when the prices are low and sell when the prices are high - a fundamental investment strategy. However, it's important not to confuse rebalancing with market timing. The goal of rebalancing isn't short-term gain but maintaining your chosen asset allocation over the long run. 

Yet, despite its benefits, one must remember that past performance does not guarantee future results. Regular rebalancing can help manage investment risk but doesn't assure a profit or protect against losses.

Taking into account tax implications and fees

The benefits of rebalancing must be weighed against potential tax implications and transaction fees. Any sale of investments could generate capital gains and, potentially, a tax liability. However, in a retirement account such as a 401(k) or an individual retirement account (IRA), the tax implications are typically deferred until withdrawal.

Transaction fees are another factor. While robo-advisors typically incorporate transaction costs into their fee, other brokerages may charge for each transaction made during the rebalancing process.

The value of diversification

Diversification is key regardless of whether you've chosen to manually rebalance or use an automatic rebalancing feature. The central idea is that different asset classes will perform differently at different times, and a mix of assets will ideally balance risk and return.

Rebalancing forces you to stay on track, in a disciplined way, with your diversification strategy. It enables you to optimize your investments and work gradually towards your long-term financial goals.

Setting your rebalancing strategy

Investors must decide their rebalancing strategy. Is it based on the calendar or the percentage change in an asset class? Will it be done by a robo-advisor or a broker? These factors depend on individual financial goals, investment mix, and risk tolerance.

Upon determining an automatic rebalancing strategy, investors should work continuously towards maintaining it. After all, financial markets can change rapidly, and a rebalancing strategy that worked well in the past might not yield the same future results.

Is automatic rebalancing right for you?

Automatic rebalancing is an efficient and emotion-free way to maintain an investor's target asset allocation, maximizing potential gains based on an individual's risk profile. Despite certain caveats, it is clear that correctly implemented automatic rebalancing can play an instrumental role in achieving financial targets. 

Whether you're a novice investor with a budding retirement account or an experienced investor trying to manage various mutual funds and ETFs, automatic rebalancing offers a way to streamline and safeguard your investment journey. The ease of use of this feature, coupled with the managed diversification and emotionless trading decisions, can be an invaluable asset to any investment strategy.

Also, remember automatic rebalancing isn't a one-size-fits-all solution. It's one of many strategies that investors can use to help manage their portfolios successfully. Consult with a financial advisor to understand if automatic rebalancing aligns with your financial goals and risk tolerance.

As with any aspect of financial planning, diligent research, proper understanding, and thoughtful implementation can produce rewarding outcomes. Stay informed, invest wisely, and may your portfolio grow successfully!

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What Is Automatic Rebalancing? Auto Rebalancing Explained

What Is Automatic Rebalancing? Auto Rebalancing Explained

Dan Kent

Dan is an active dividend and growth investor. One of the founders of Stocktrades.ca, an investment platform with over 300,000 monthly visitors, his message was and still is that anyone with dedication and determination can accomplish their goals even if they start out with little knowledge of the playing field, in this case, the global markets. Dan's articles have numerous mentions in the Globe & Mail, Forbes, Winnipeg Free Press, CBC, Entrepreneur, Kiplinger, and other high-authority financial websites. He has also worked with notable financial institutions such as Questrade, Qtrade, Bank of Montreal, and Toronto-Dominion Bank. He has become an authority figure in the finance niche. This is primarily due to his attention to detail and dedication to achieving the highest investment returns. Investing on his own since he was 18 years old, Dan has compiled the necessary experience and knowledge to be successful in the world of self-directed investing. He has completed the Canadian Securities Course, and along with that, brings 14+ years of self-directed investing experience via the Stocktrades blog, to passive investing seekers on RoboAdvisorPros, and on a whole other level over at Stocktrades Premium, highlighting strong opportunities for investors since 2016.