What is rebalancing? Rebalancing is when you re-assess your investment portfolio and adjust your holdings such that you return to the percentage allocations you planned for when you started the year. So, if you started the year 80% stocks, 20% bonds and, through the course of gains and losses, you find yourself at 75% stocks and 25% bonds at the end of the year – you should rebalance it by selling off some of your bonds and moving it into stocks. Rebalancing your portfolio is a crucial component of your retirement investing strategy for many reasons – not the least of which is the fact that you should stick to your plan and not let the latest hot run-up distract you.
1. Buy Low, Sell High
This is the cornerstone of rebalancing. If at the end of the year you have a higher percentage than you initially planned, then one can only surmise that it increased in value relative to the other holdings you have. Thus, it is now high and so you should sell it. The proceeds from that investment should go towards the allocation that has fallen during the course of the year – thus you are buying low. Buy low, sell high. You’ve been hearing it for years!
2. Stick To Your Plan
After you decided 80% stocks and 20% bonds should be your mix, you need to stick to your plan unless you have a good, unemotional reason not to continue on that path. Maybe you recognize the absence of international exposure, so you want 50% stocks, 20% bonds, and 30% international. Maybe you recognize an overallocation into stocks and want to ratchet it back to 60% stocks and 40% bonds. Unless you have a concrete reason for changing, you should rebalance and follow the plan of attack you set up for yourself twelve months ago.
3. It Makes Mathematical Sense
The math behind it is irrefutable and it does in part have to do with Reason 1: Buy Low, Sell High. For a the math explanation, please read Why Portfolio Rebalancing Works ? It?s More Powerful than You Probably Think.
So go rebalance!