Investors may notice that their exchange traded fund investment portfolio’s allocations will drift over time. Consequently, it is important to rebalance a portfolio regularly or at least annually to effectively managed risk and market exposure.
Paul Zemsky, chief investment officer of Voya Investment Management, points out that the equities portion of an investment portfolio will typically outperform fixed-income assets and gradually cause the portfolio to grow more equity heavy, writes Shelly Schwartz for CNBC.
To diminish the rising exposure to riskier stocks, investors should rebalance their positions. Zemsky argues that a well-balanced portfolio is less volatile and helps people maintain their long-term investment goal. Essentially, investors would have to be disciplined and sell off better performing assets and bring back weights in the underperforming assets.
“Sectors get frothy, people get overly optimistic, and expectations get built in that can’t be met,” Zemsky said. “You have to sell off the overweight, which should lead to better returns over time.”
According to Morningstar data, a portfolio with 60% exposure to the S&P 500 and 40% to government bonds generated almost 15% total return between January 2004 and December 2013 if rebalanced annually – total equity and fixed-income weights are brought back to 60% and 40%, respectively. However, that same portfolio would have returned 7.5% if left completely untouched.
However, investors need to keep in mind commission-fees when rebalancing their portfolios. If an investor messes with their portfolio set up too often, they run the risk of accumulating costly trading fees that could eat away at the potential benefits of rebalancing in the first place. [Popular Commission-Free ETFs on Schwab OneSource]
Consequently, some financial planners recommend rebalancing at the end of each calendar year, some review portfolios quarterly, and others reset holdings if their target mix is off by 10% or more. According to Vanguard Group, investors should monitor holdings annually or semiannually, rebalancing when target allocation drifts by 5% or more.
Furthermore, investors can check if their brokerage platform offers commission-free trades on ETFs to help minimize costs. For instance, Fidelity, TD Ameritrade, Charles Schwab, E*Trade and Vanguard all offer a range of commission-free ETFs on their trading platforms. [Six Popular Commission-Free ETF Trading Platforms]
For more information on investing in ETFs, visit our ETF 101 category.
Max Chen contributed to this article.