Whether the market is setting new highs or in the midst of a downturn, investors need to think a few steps ahead to ensure they’re prepared when current conditions change—that’s where rebalancing comes in. During periods of extreme market volatility, like March 2020, retirement accounts and taxable investment accounts can quickly drift—and considerably—from the original target allocation as the value of the holdings increases (or decreases) sharply relative to the rest of your account.

As a result of the COVID-19 outbreak, investors with stocks and bonds in their portfolios may notice their accounts have grown considerably more conservative over the last few weeks—and this might not be a good thing.

Rebalancing recalibrates your asset allocation

Rebalancing is the process of periodically comparing your original asset allocation to your current portfolio, and if the holdings vary more than a maximum threshold of your choosing, then it may be time to rebalance.

When you rebalance, you sell a portion of your portfolio that was outperforming (or underperformed less on a relative basis) and buy more of the underperforming asset to bring the investment mix back the way you originally intended.

It may seem counterintuitive to sell an investment that has been outperforming but remember: past performance does not indicate future results. If you had not been periodically rebalancing your accounts before a market correction, the unbalanced portfolio could be exposed to much more risk than an investor may reasonably expect.

This can happen when stocks surge relative to bonds. For example, in 2019, the S&P 500 returned over 31% while U.S. bonds (which also had a banner year) were up nearly 9%. Left unbalanced, your weighting to stocks would be higher at the end of the year relative to bonds. Investors overweight to equities at the beginning of 2020 would have been overexposed to the rapid selloff in the stock market.

Rebalancing if often done at stated time intervals and/or when a portfolio drifts outside a stated tolerance range from the target.

Should you rebalance when the market is up or down?

It is only in hindsight that we can tell where the top or the bottom was in a market cycle. Market timing requires investors to find the best time to sell (at the top) and then again when the market is at the bottom: two events that are nearly impossible to get right. Rebalancing is more about sticking to your plan than it is timing the market.

Rebalancing is one way for investors to position themselves to withstand a downturn in the market and participate in the recovery as well.

For example, during sharp downturns, your portfolio can deviate from target very quickly. For example, if you had a 70/30 portfolio of stocks and bonds on January 1st and left it alone, by March 24th the account would have drifted to 64% stocks and 36% bonds.*

You may be thinking, good; I’m glad my account is more conservative, perhaps that will protect me from further losses in the stock market. While that could be true, you also need to think about how that will impact your ability to participate in the recovery.

For example, despite the sharp downturn in 2008, the S&P 500 went on to return over 26% in 2009. Bonds on the other hand returned almost 6% as measured by the Bloomberg Barclays US Aggregate Bond Index.

March 2020 is on pace to make history as the most volatile month in the stock market: through March 27th, the average daily swing for the S&P 500 was 5.2%. The previous record was 3.9%—from November 1929.

Amidst such volatility, it isn’t always wise—or even feasible—to ensure your portfolio is constantly on target. The wild swings in the stock market have even happened on back to back days: on March 12th, the S&P 500 posted a -9.51% loss only to turn around the next day and close +9.29%. If you had rebalanced after the big down day, you could be off target the very next day.

Navigating the current investment climate can be very challenging. It’s important to consider both tried-and-true investing principles as well as common sense. Trading during these particularly volatile bouts may not make sense, so investors will need to balance their pre-COVID-19 investment plan with current conditions, their risk tolerance, time horizon, and the transaction costs of rebalancing.

Opportunity to make other strategic changes to your investments

The process of rebalancing is a natural opportunity to change up your asset allocation if you’re not confident in your original strategy or if there have been any changes to your life that need to be reflected in your portfolio’s asset allocation. Despite the current volatility, it’s important to resist the urge to cut your losses and go to cash. Most of us are investing for the long-term—so short-term dips in the market are to be expected over decades-long investment horizons.

Rebalancing can be done very efficiently if you feel the current market presents a buying opportunity and want to invest new money. Rather than try to get all your accounts to look like their own complete portfolio, consider trying to look at the big picture and focus on getting your overall investment picture on target. This can reduce transaction costs.

It’s also a good time to consider tax-loss harvesting to realize losses in a brokerage account that can be used to offset gains from positions that have grown substantially in recent years. There are a number of considerations to be aware of before harvesting losses for tax purposes, so be sure to understand the pros and cons before selling.

Even in normal markets, rebalancing is a blend of art and science. But that doesn’t mean periodically recalibrating your 401(k), IRAs, and taxable accounts isn’t an important part of navigating choppy waters in the financial markets. Whether the market is setting new highs or in the midst of a downturn, investors need to think a few steps ahead to ensure they’re prepared when current conditions change.

This article was written by Kristin McKenna, CFP® and originally published by Forbes.

* SPDR¨ S&P 500 ETF and 30% bonds; iShares Core US Aggregate Bond ETF

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