How to Rebalance Your Portfolio for the Second Half of the Year

The financial landscape shifts throughout the year, influenced by economic conditions, market movements, and changes in personal financial priorities. Whether interest rates have changed, certain asset classes have outperformed, or your risk tolerance needs to be adjusted, reviewing a portfolio periodically can help keep it aligned with long-term objectives. 

Portfolio rebalancing is a method for managing investment risk and maintaining diversification. Over time, market fluctuations can cause asset allocations to drift from an original plan, which may lead to increased risk exposure or a different growth trajectory than intended.  

Rebalancing is not about reacting to short-term market trends but about maintaining an investment strategy that reflects financial priorities. The following sections outline key steps for reviewing a portfolio, assessing allocation shifts, and making adjustments based on individual circumstances. 

Why Rebalancing Matters 

Market fluctuations can shift the balance of a portfolio over time, potentially leading to unintended levels of risk or a different investment mix than originally planned. For example, if stocks have performed well, they may make up a larger percentage of a portfolio than intended, increasing exposure to market volatility. On the other hand, if bonds or other conservative investments have grown, a portfolio may become more risk-averse than originally designed. 

Without periodic rebalancing, these shifts can lead to: 

• Increased Risk Exposure: A higher concentration in one asset class can increase vulnerability to market downturns. 

• Lower Growth Potential: A more conservative allocation than intended may limit opportunities for long-term growth. 

• Diversification Drift: Over time, certain investments may take up a larger share of the portfolio, reducing the intended level of diversification. 

Review Your Current Asset Allocation 

A portfolio’s asset allocation shifts over time due to market movements, potentially leading to a different investment mix than originally planned. Reviewing asset allocation periodically helps identify whether adjustments may be needed based on financial goals and risk tolerance. 

Key Considerations When Reviewing Asset Allocation: 

• Compare Current vs. Target Allocation: Assess how investments are currently distributed across asset classes (stocks, bonds, cash, and alternative investments) and compare them to the original strategy. Market performance may have resulted in certain investments making up a larger or smaller portion of the portfolio. 

• Assess Investment Performance: Review how different asset classes have performed this year. Some investments may have appreciated significantly, while others may have declined. These shifts can change the overall balance of the portfolio. 

• Evaluate Risk Tolerance and Investment Horizon: Risk tolerance and financial priorities can evolve. A portfolio that was appropriate in previous years may no longer reflect current financial circumstances or long-term objectives. 

Understanding how a portfolio has changed over time provides a basis for deciding whether adjustments may be necessary to maintain the intended investment approach. 

Consider Market Trends and Economic Factors 

Economic conditions play a significant role in investment performance. Factors such as interest rates, inflation, and overall market trends can shift the outlook for different asset classes, potentially affecting portfolio balance. 

Key Factors to Review: 

• Interest Rates: Changes in interest rates can impact bonds, stocks, and real estate investments. Rising rates may reduce bond prices, while lower rates can boost borrowing and economic growth, influencing stock performance. 

• Inflation: Higher inflation can erode purchasing power and affect different asset classes in various ways. Stocks and real assets like commodities may respond differently than bonds, which can lose value in a rising inflation environment. 

• Market Performance: Sectors react differently to economic shifts. For example, technology and growth stocks may perform well in low-interest-rate environments, while defensive sectors like healthcare or consumer staples may be more stable during economic downturns. 

• Sector and Asset Allocation Adjustments: Depending on economic conditions, certain sectors or asset types may warrant closer review. A well-diversified portfolio includes a mix of assets that align with an investor’s goals, rather than being overly concentrated in one area. 

Strategies for Rebalancing 

Rebalancing adjusts a portfolio’s asset allocation to bring it back in line with its original strategy. The approach used depends on factors such as market conditions, tax considerations, and cash flow. 

Key Rebalancing Strategies: 

• Sell Overperforming Assets: If certain investments have grown beyond their target allocation, selling a portion may help redistribute risk. In taxable accounts, selling may trigger capital gains taxes, which should be factored into the decision. 

• Buy Underweighted Assets: Some asset classes may represent a smaller portion of the portfolio than originally planned. Reinvesting in those areas can help maintain diversification. 

• Use New Contributions: Directing new contributions toward underweighted assets allows for gradual rebalancing without selling existing holdings, which may help reduce taxable events. 

• Tax-Efficient Adjustments: In taxable accounts, tax-loss harvesting—selling investments at a loss to offset gains—may be an option to manage tax liability. Adjustments within tax-advantaged accounts, such as IRAs or 401(k)s, do not trigger immediate taxes. 

Rebalancing in Tax-Advantaged vs. Taxable Accounts 

Rebalancing has different tax implications depending on the type of account. Tax-advantaged accounts allow for adjustments without immediate tax consequences, while taxable accounts require consideration of potential tax liabilities. 

Tax-Advantaged Accounts (401(k), IRAs, etc.) 

• Trades made within tax-advantaged accounts do not trigger capital gains taxes. 

• Adjustments can be made without tax concerns, providing flexibility in asset allocation. 

• Required minimum distributions (RMDs) in retirement accounts may influence rebalancing decisions. 

Taxable Accounts 

• Selling assets in taxable accounts can result in capital gains taxes. Long-term gains are taxed at a lower rate than short-term gains, which are taxed as ordinary income. 

• Tax-efficient strategies, such as tax-loss harvesting (selling underperforming assets to offset gains), can help manage tax impact. 

When to Rebalance 

Rebalancing can be done at different intervals or based on specific triggers. The approach depends on factors such as investment goals, risk tolerance, and market conditions. 

Time-Based Approach 

• Rebalancing on a set schedule, such as semi-annually or annually, provides consistency in reviewing asset allocation. 

• This method does not rely on market fluctuations but instead follows a routine assessment of the portfolio. 

Threshold-Based Approach 

• Rebalancing is triggered when an asset class deviates by a certain percentage from its target allocation. 

• For example, if equities were initially set at 60% of the portfolio but have grown to 70%, adjustments may be made to bring them back in line. 

• This approach responds to market movements rather than a fixed calendar schedule. 

Combination Approach 

• A mix of both methods, where a portfolio is reviewed at set intervals and adjustments are made if assets have moved beyond a specific threshold. 

• This approach provides regular oversight while allowing for flexibility based on market shifts. 

Seeking Professional Guidance 

Rebalancing involves more than adjusting asset allocations—it requires evaluating risk tolerance, tax implications, and long-term financial objectives. While some investors manage this process independently, others consult professionals for insights on portfolio strategy and tax considerations. 

Considerations When Seeking Professional Guidance: 

• Assessing Portfolio Adjustments: A professional can review whether a portfolio’s current allocation aligns with investment objectives and risk tolerance. 

• Tax-Efficient Strategies: Selling assets in taxable accounts may result in tax consequences. Professionals evaluate tax-efficient approaches, such as tax-loss harvesting or reallocating within tax-advantaged accounts. 

• Market and Economic Insights: Economic shifts, interest rate changes, and market conditions influence investment strategies. Professionals provide analysis on how these factors may impact rebalancing decisions. 
  
  

Conclusion 

The midpoint of the year presents an opportunity to review portfolio performance, assess asset allocation, and determine whether adjustments are needed. Market fluctuations, economic changes, and evolving financial priorities can shift a portfolio away from its original strategy. Regular rebalancing helps maintain diversification and align investments with long-term objectives. 

Taking a structured approach—whether through a time-based schedule, threshold deviations, or a combination of both—can help keep a portfolio on track. Evaluating tax implications and considering broader economic trends are also important factors in the rebalancing process. 

For a step-by-step guide to reviewing key areas of your financial plan, download your Retirement Spring Cleaning Checklist to help organize and assess different aspects of your portfolio. 

For those looking for additional insights, Liberty Group provides guidance on portfolio management, tax considerations, and long-term financial planning. To discuss rebalancing strategies in more detail, contact our team.