Reuters Money

As the calendar turns over to a new year, many people are compelled to lose weight, eat better and get organized. And for investors, it’s the most popular time to get their portfolio back in shape by rebalancing.

But whether or not rebalancing does what it is supposed to do — ensure that investors buy low and sell high — has been the subject of some debate. Even so, most experts agree that rebalancing has its merits. “Rebalancing provides a disciplined strategy to risk management,” says Jonathan Bergman, a certified financial planner with Palisades Hudson Financial Group.

Indeed, target asset allocations change over time as different asset classes produce varying returns. But for any number of reasons, from procrastination to cost, investors often don’t take action when they should.

So in order to maintain the risk-and-return characteristics of a portfolio’s target allocation, “rebalancing forces investors to take profits in areas of their portfolio that has done well and invest at lower prices in areas of their portfolio that may be currently out of favor,” says Justin Sinnott, a financial consultant with Charles Schwab. Even though investors can’t control the direction of the market, they can control how much exposure they have to risk through asset allocation.

But questions still abound: How often? How far? How much? The challenge to rebalance plagues many individual investors. While there are no cut and dry answers, here are some rebalancing guidelines:

Frequency. Recent Vanguard research found that the risk-adjusted returns don’t differ significantly whether a portfolio is balanced monthly, quarterly, or annually. What matters more, however, is the number of times a portfolio is rebalanced. Costs can significantly increase when rebalancing takes place more frequently.

Strategy. Portfolio managers have different strategies that will trigger rebalancing. While some may do it by calendar year, “we do it based on market dynamics so it could be every week or every year,” says Matthew Tuttle, CEO of Tuttle Wealth Management and author of How Harvard & Yale Beat the Market. If the target allocation gets out of whack by a specific metric, say 5 percent, then he will rebalance.

At Palisades Hudson Financial Group, bands are set. When a category deviates 10 percent from its target, “that’s our trigger to rebalance,” says Bergman. “If a portfolio was 60/40 and stocks got to be 66 percent or 67 percent, then we would rebalance,” he says noting that for individual investors, once or twice a year is sufficient to reset the portfolio, depending on market volatility. Schwab recommends that investors rebalance at least quarterly or if any asset class is out of sync by 5 percent or more.

Investors who work with money managers ask about the rebalancing strategy to ensure that there is some form of disciplined policy governing the decision making process.

Taxes. Of course, there is a tax impact to selling. In order to book long-term capital gains, currently taxed at 15 percent and more appealing than paying short-term capital gains, you should try to rebalance at least once a year. But “don’t let the tax tail wag the dog,” says Tuttle. “I’d rather make 15 percent and take out 3 percent on taxes because this will make the investment more money at the end of the day,” he says.

Be mindful if there is a big gain. “We will see if we can rebalance into a tax-deferred account,” says Bergman.

Other costs to be aware of include short-term redemption fees and other fees associated with selling that the brokerage firm holding the security can impose.

Whatever strategy you use, check your emotions at the door. “The rebalancing decision should be based on established target asset allocation and not on the most recent short-term market moves or media headlines,” says Sinnott.