Portfolio rebalancing is important because it helps investors maintain target asset allocations. Rebalancing helps reduce “portfolio drift” and reduces exposure to risk outside of a desired, targeted asset allocation.
What is Portfolio Rebalancing?
* The process of realigning the weightings (positions) in a portfolio of assets.
* Typically periodic buying and selling of assets to maintain an original or desired level of asset allocation or risk.
* Example = Your goal is 50% stocks and 50% bonds, but stocks outperform over a period of time, and now your portfolio is 70% stocks. This would need adjustment to maintain your asset allocation goals.
* The tricky part is how to allocate individual stocks within your stock bucket.
* First you need an overall investing plan. Then a rebalance method…
Two Methods to Rebalancing:
1. Periodic Rebalancing - This method requires very little effort on your part outside of your commitment to do it.
* Choose a preset time interval…usually quarterly, every six months, or annually.
* Set a reminder.
2. Tolerance Rebalancing - This method also helps you rebalance your portfolio to align with your intended asset allocation, but is based on a percentage change in your allocation.
* This is what I do. It’s based on percentages, and is best for more actively managed portfolios.
* Simple approach = % of stocks vs bonds
* Advanced approach = % of each individual stock within your stock bucket.
* During volatile markets, this approach carries higher risk and more expense.
* Method will likely change as you age and your portfolio grows.
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