Rebalancing
Sell high, buy low. Without predicting the market.
Over time, as your purchased asset classes increase and decrease in value, your overall allocation will shift from its target. Rebalancing brings that imbalanced allocation back in line.
Suppose your total portfolio value is $100 and your target allocation looks like this:
| Investment | Amount | Percentage of Total |
|---|---|---|
| Stocks | $50 | 50% |
| Bonds | $50 | 50% |
| $100 (Total) | 100% |
Say that stocks gain 30% this year, while bonds lose 10%. At the end of the year, your portfolio will have increased in total value by 10%, to $110, but its allocation will have shifted to become:
| Investment | Amount | Percentage of Total |
|---|---|---|
| Stocks | $65 | 59% |
| Bonds | $45 | 41% |
| $110 (Total) | 100% |
By rebalancing, we sell $10 of stocks and buy $10 of bonds, bringing the overall allocation back to its original target.
| Investment | Amount | Percentage of Total |
|---|---|---|
| Stocks | $55 | 50% |
| Bonds | $55 | 50% |
| $110 (Total) | 100% |
Why bother rebalancing?
By continually selling what’s gone up, and buying what’s gone down, in the long run you are buying more of what is cheap and less of what is expensive, increasing returns while preserving the “risk versus return” characteristics of your target asset allocation.
How often should you rebalance?
About once per year should be fine, or when any asset class is 20% off its target. For example, for a 50% stock allocation, we’d rebalance if that asset class grew to 60% (50% x 1.2) or dropped to 40% (50% x 0.8).