The Investing Strategy Smart Physicians Use to Optimize Their Wealth

An investment portfolio is a lot like a dinner plate. The most nutritious plate has a little bit of everything on it. Along the same lines, you want a diversified portfolio that holds different types of assets (stocks, bonds, real estate) across different sectors (technology, telecommunications, manufacturing).

And, like food choices, investing preferences often change over time. When you’re young, you might be comfortable throwing money at speculative investments, like crypto or a specific company’s stock, which are risky but have the potential for high growth. But your palate should become more refined over the years, as you increasingly focus on stable, low-growth investments. Other factors besides age also influence the types of investments you make.

Common-sense investing advice says to start as early as possible — ideally in your early or mid 20s. This rule of thumb can be tough to follow for physicians, who are often saddled with student loan debt and might not earn enough to consider investing until their 30s. Still, meaningful wealth accumulation is possible if you invest wisely and keep your portfolio aligned with your goals.

A key aspect of managing investments is portfolio rebalancing. This process involves adjusting your investments to match your target asset allocation, which is the optimal mix of investments in a particular portfolio. Your portfolio’s asset allocation will inevitably get out of whack as some investments perform well and others do poorly.

Your target asset allocation will depend on your time horizon, or the amount of time until you plan to start drawing money from the account. In other words, your 401(k) and IRA, which you don't plan to draw from for another 30 years, can be invested more aggressively than a brokerage account that you’re planning to put toward a home purchase in 10 years. When rebalancing, you can think of accounts invested for the same purpose (such as for retirement or a child’s education) as one account, even if the funds are held across multiple accounts.

So, rebalancing is an opportunity to right-size your portfolio, and it also helps separate investing decisions from emotions that often lead us astray. By selling winning investments when they’ve become an outsized part of your portfolio, you’re working to maximize your risk-adjusted returns. This is the amount earned on your investments, keeping in mind your level of risk tolerance for losing money.

There are three rebalancing strategies: periodic, tolerance, and a hybrid of the two. Let’s take a look at each one.

Periodic investment rebalancing

You can choose to rebalance your portfolio at set intervals — typically quarterly or annually. At this time, you’ll review your investment portfolio’s performance in the past period, sell outperforming investments, and then put that money into other areas to achieve your target asset allocation.

Case study: Dr. Susie rebalances her portfolio every June. Last June, she settled on the following target asset allocation: 50% stocks, 40% bonds, and 10% cash. Before rebalancing this June, her asset allocation is 65% stocks, 30% bonds, and 5% cash. She’ll rebalance by selling a considerable amount of stock, purchasing bonds, and keeping some cash.

Note that Dr. Susie should also take this time to revisit whether her target asset allocation still meets her needs. She might decide that a 55% stock, 35% bond, 10% cash portfolio suits her needs better and rebalance based on this new target asset allocation.

Tolerance threshold investment rebalancing

Some investors only rebalance their portfolios when their portfolio’s asset allocation has strayed outside a specified threshold. Unlike the periodic rebalancing strategy, the tolerance threshold strategy requires constant investment performance monitoring, which is onerous, if not impractical, for busy physicians. However, many brokerage firms allow you to set alerts when your portfolio has deviated too far from its target asset allocation. For example, Vanguard calls this feature Portfolio Watch.

Thresholds are typically expressed as a percentage and can be fixed or relative. These case studies illustrate the difference:

Case study: Dr. John has a target asset allocation of 50% domestic stocks, 20% international stocks, 20% bonds, and 10% cash. He sets a five-percentage-point fixed threshold for rebalancing, which means that if any asset’s allocation moves by five percentage points, he’ll rebalance the entire portfolio. Therefore, when domestic stocks became 55% of his portfolio, he rebalanced to return to his target asset allocation. He’d do the same if bonds became only 15% of his portfolio.

Case study: Dr. Jake has the same target asset allocation as Dr. John, except that he uses a 20% relative threshold for rebalancing. With this rebalancing strategy, Dr. Jake wouldn’t rebalance his portfolio merely because his domestic stock allocation became 55%. He would wait until that allocation reached 60%, because 20% of the target 50% is ±10%. He would also rebalance if bonds became only 16% of his portfolio (20% of the target 20% is ±4%).

Hybrid investment rebalancing

The final option is perhaps the happy medium of rebalancing strategies. A hybrid rebalancing approach involves periodically reviewing your asset allocation and only making changes when it’s shifted beyond a set threshold.

Case study: Dr. Melissa’s target asset allocation is 70% stocks, 20% bonds, and 10% cash. She reviews her investments quarterly and only rebalances when any asset’s allocation changes by more than 10% (a relative threshold). So, Dr. Melissa won’t rebalance her portfolio when it shifts to 65%, 21% bonds, and 14% cash because none of the asset allocations drifted by more than 10% from their target.

Warning: Tax bill incoming

Rebalancing investments within taxable accounts (accounts that are not a traditional retirement account, such as a traditional 401(k), 457(b), 403(b), or IRA) will create a taxable event. In other words, you’ll owe capital gains taxes on any money you make from investments you sell. Your tax rate will depend on whether or not you hold the investment for more than a year and what your income is for the year.

Join the discussion

Whether you’re managing your own investments or working with a financial advisor, rebalancing is a necessary part of investment management. Which approach will you use to prune your investment portfolio?