Rebalancing

Why Rebalance?

Over time, the asset allocation of your portfolio will drift away from its original target. This happens because different asset classes grow at different rates. For example, if stocks have a strong year, your stock allocation will increase, and your bond allocation will decrease. This drift can leave you with a portfolio that is riskier than you intended. Rebalancing is the process of bringing your portfolio back to its original target asset allocation.

The Rebalancing Process

Rebalancing involves selling some of the assets that have performed well and using the proceeds to buy more of the assets that have underperformed. For example, if your target allocation is 60% stocks and 40% bonds, and after a year it has drifted to 70% stocks and 30% bonds, you would sell some of your stocks and buy bonds to get back to your 60/40 target. This forces you to systematically sell high and buy low.

How Often Should You Rebalance?

There are two main approaches to rebalancing:

• Time-Based Rebalancing: This involves reviewing and rebalancing your portfolio on a regular schedule, such as quarterly, semi-annually, or annually. Annual rebalancing is a popular and effective strategy for most investors.
• Threshold-Based Rebalancing: This involves rebalancing only when the weighting of an asset class deviates from its target by a predetermined percentage (e.g., 5%).

A combination of both approaches can also be effective. The most important thing is to have a disciplined rebalancing plan and to stick to it, rather than trying to time the market.