Some say diversification is the only free lunch in investing. This article begs to differ. Rebalancing your portfolio is a free lunch as well. It costs you nothing but a little time and helps keep your portfolio tuned to the all-important level of risk that’s right for you.
A little background
Asset allocation is arguably the most crucial determinant of your success as an investor. Typically, it refers to the mix of higher-risk/higher-potential return investments and lower-risk/lower-typical return investments in your portfolio. A basic tenet of investing is that a young person with a long time horizon can and should tune their portfolio to the riskier side of the dial. With time on their side, they can handle market fluctuations in pursuit of better returns. On the other hand, an older person with a shorter time horizon should choose a more conservative approach. They can’t afford to take as much risk because they have less time for their portfolio to recover from a market downturn.
Getting your portfolio aligned with your risk tolerance is well and good as a starting point. The problem is, over time, as investment returns ebb and flow, the optimal asset allocation you started with will change and become less than optimal. In a good year for the market, your more aggressive investments will outperform your more conservative investments. You may have started with an 80/20 portfolio (80% stocks, 20% bonds) only to end the year with an 85/15 or a 90/10 portfolio. In a bad year, the opposite will happen.
If 80/20 was the right allocation at the start of last year, it’s likely still to be the right allocation now, so it’s time to rebalance. In other words, it’s time to sell some of your stock-based holdings and use the proceeds to buy more bond-based holdings. But rebalancing isn’t just about resetting your investment mix. In fact, three parts of your portfolio may need rebalancing.
Your strategies
For many years, SMI didn’t take a strong position on which strategy is best for particular members. We described each strategy, explained how each was expected to perform, and let people make their own decisions.
Of course, members are still free to choose! However, in recent years, we have become convinced that most members would benefit from adopting a blended strategy approach, with the default being 50/40/10—50% Dynamic Asset Allocation, 40% Fund Upgrading, and 10% Sector Rotation. It’s fine to tailor that blend—65/30/5, for example. The important point is that there are benefits to be had—such as reducing volatility and even boosting returns—by using multiple SMI strategies to manage your portfolio.
If that’s how you’re investing, over the course of a year, one strategy is likely to perform better than another. In 2025, for example, DAA shined bright. So, if you are using a blended strategy approach, it’s likely that DAA now makes up a larger percentage of your portfolio than it did at the beginning of 2025 and the other two strategies constitute less. It would be wise to realign them. SMI’s 50/40/10 online calculator can help.
Your asset classes
Two of SMI’s strategies, Just-the-Basics and Fund Upgrading, require investors to first determine their optimal asset allocation. This can be accomplished by taking SMI’s online risk tolerance quiz and pairing the results with your “season of life.” If you’re married, both of you should take the quiz separately. If your optimal asset allocations differ, meet in the middle.
(Dynamic Asset Allocation bypasses this step as its design shifts you into and out of entire asset classes based on momentum.)
As noted earlier, the stock/bond mix you started 2025 with is probably not the mix you ended with. However, before you realign your allocations, take the quiz again to see if the results have changed. Your risk tolerance may still be the same, but you are a year older and may have moved into a new season of life.
Your investments
Each SMI strategy involves holding multiple mutual funds and/or exchange-traded funds. Again, some funds likely performed better than others. For example, DAA monitors the performance of six ETFs, keeping those following the strategy invested in the three with the highest momentum. The strategy held a gold fund (PHYS) throughout 2025, which had a tremendous year. If you are using that strategy, it’s likely that gold now makes up more than one-third of your DAA holdings. It’s time to bring it into balance.
Common questions
A few of the most frequent questions we hear about rebalancing include:
Why not just let my winners run?
In other words, with gold doing so well 2025, why not let your DAA holdings continue to tilt more heavily in that direction? Or, if you’re following Fund Upgrading, AVALX has had a tremendous run, so why not just leave it alone?Those are reasonable questions. Some members gradually rebalance their holdings as they go, as changes occur within the strategies. That’s fine, but it’s more of an “advanced” technique. The simpler approach is to handle the rebalancing all at once: calculate all the numbers, make any appropriate rebalancing trades, and move forward. Doing so acknowledges no one knows the future and enforces a discipline of trimming big winners and reducing the risk of carrying larger than intended positions forward.
How precise do I need to be?
The short answer is, “Not overly precise.” Think of asset allocation as a fairly blunt instrument. You don’t need to rebalance your portfolio every month—once a year is sufficient. And you don’t have to hit the exact percentages recommended for each investment. If you can get within a few percentage points of your allocation targets, that’s close enough.
Rebalancing your portfolio is like getting your car’s oil changed regularly. You may not notice a change in performance right away, but failing to do so could lead to costly problems down the road.
