5 Steps to Reviewing and Rebalancing Your Portfolio

From time to time it is important to review the investments you hold in your portfolio and rebalance the allocation of those investments.  Here are some steps to follow when you decide to review and rebalance.

  1. Reinvest Dividends
    Before you review and rebalance your portfolio, you must be sure to keep all the dividends you have received in the investment account to be reinvested.  Reinvesting dividends is one of the most important steps in long-term investing as it helps to boost the gains and limit any losses.For example, if a company has a dividend yield of 3% at the time you purchase it, that means that you can lose a couple percentage points each year on the price of the company and still break even – or if you’re aiming for an 8% yield overall, the capital appreciation can be as low as 5%.Of course, the math is a little bit more complicated than that and the dividend  yield can actually be even more effective as it is compounded over time, but this is good enough for you to get the idea.
  2. Review Each Investment
    One important concept to remember that many people don’t follow is to review your investments periodically to determine if they are  still suitable for your situation.  For the defensive or enterprising investor following Benjamin Graham’s principles from The Intelligent Investor, that may mean putting the company through a series of tests (see Browse Valuations by Investor Type for an easy outline of the tests).If you would not purchase a company today because it would not be suitable for your investment goals and requirements, why would you continue to own it?  Sometimes companies exhibit signs of financial strain before the stock price falls and it can be beneficial to review for signs of stress.In addition to reviewing for investment qualifications, you must determine the intrinsic value of the investments periodically.  On ModernGraham, we have a simple valuation calculator that can help to determine the value based on Benjamin Graham’s formula presented in The Intelligent Investor (IV = EPS x (8.5 +2g)).It is important to have set target selling points in relation to the intrinsic value.  For example, if you have a buy target price of less than 75% of the intrinsic value, perhaps you also have a selling point of more than 125% of the intrinsic value.  The price will fluctuate from time to time, and it may be a good idea to sell when it gets significantly higher than the calculated intrinsic value.
  3. Review Portfolio for Deviations from Target Allocation
    It is important to have a target allocation level for each investment – being sure to include any cash balances from the dividends you have received.  For example, if you want to own 10 different investments at a time, a simple target allocation level would be 10% of your portfolio allocated to each investment.  Some people choose to increase the allocation level for individual investments and decrease it for others, depending on market conditions.  There are costs and benefits of doing this and we will not get into it in this article; however the basic principle remains the same.In addition to having a target allocation level, you should determine a trigger point for rebalancing.  If you have a target allocation level of 10%, perhaps your trigger level for selling some shares is when the investment becomes 11% or more of your portfolio.  In that case, you should also have a trigger level for buying shares set at 9% of your portfolio.
  4. Buy and Sell Shares to Regain Target Allocation
    Once you know which companies have deviated from the target allocation enough to trigger a buy or sell situation, you can go ahead and calculate the amount of shares needed to regain the target allocation.For example, if a company is currently worth $11/share and you own 1,000 shares for an $11,000 investment that equals 11% of your $100,000 portfolio, you would need to sell $1,000 worth of the shares you own, or approximately 91 shares.  After selling the shares, you would be left with 909 shares worth $9,999.After selling the shares, you can use the cash to purchase the shares of the companies that have dropped in allocation.  The math is the basically the same, only done from a purchasing standpoint rather than a selling standpoint.
  5. Sit Back and Watch Until it is Time to Rebalance Again
    After you finish rebalancing the portfolio, the best thing you can do is step away from the stock market until it is time for you to review and rebalance the portfolio again.  Mr. Market will fluctuate and there is no need to be consumed by each fluctuation.  Just set a time frame for each review and rebalance period, and make sure to follow the steps outlined here.

Do you have any other steps that you take?  Tweet those ideas to us at @moderngraham, then follow us to see more!


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