In effect, rebalancing implements the advice to buy low and sell high. Many investors rebalance according to a set schedule, such as quarterly or annually, or when the allocation of any asset class changes by more than 5 percentage points from the target asset allocation.
Rebalancing by set asset targets is a good way to approach portfolio rebalancing since markets can change more in some time periods than in others. A standard rule of thumb is to rebalance when an asset allocation changes more than 5%—ie. if a certain subset of stocks changes from 15% of the portfolio to 20%.
While there is no required schedule for rebalancing a portfolio, most recommendations are to examine allocations at least once a year. It is possible to go without rebalancing a portfolio, though this would generally be ill-advised.
Balancing your portfolio ensures that you have a mix of investment assets -- usually stocks and bonds -- appropriate for your risk tolerance and investment goals. Rebalancing your portfolio allows you to maintain your desired level of risk over time.
Remember that over the long term, stocks have a significantly higher expected return than bonds. ... For this reason, rebalancing a portfolio of stocks and bonds is therefore likely to lower your returns, not increase them.
Rebalancing your portfolio on your own, without the help of a robo-advisor or investment advisor, doesn't require you to spend any money.
Typically, balanced portfolios are divided between stocks and bonds, either equally or tilted to 60% stocks and 40% bonds. Balanced portfolios may also maintain a small cash or money market component for liquidity purposes.
Use tax-favored retirement accounts.
Taking gains inside plans such as 401(k)s and individual retirement accounts (IRA) will not generate current taxes. Therefore, Ellen may be able to do some or all of her rebalancing, tax-free, by moving from stocks to bonds within her IRA.
To rebalance, you simply make the appropriate trades to return your mutual funds back to their target allocations. For example, returning to our 5 fund portfolio example, you would buy and sell shares of the appropriate funds to get back to the original 20% allocation for each fund.
Building a balanced portfolio
Rebalancing usually does not increase long-term investment returns. It may reduce the volatility of your investment portfolio and keeps the asset allocation in sync with your risk tolerance.
How much of your portfolio should be in one stock? For any investor, it is safe to say that no single stock should be more than 5-6% of the entire portfolio, as suggested by Seth Klarman, a successful investor and author. This is Rule No 1 of stock investment.
Periodic rebalancing is generally a good way to keep your investing strategy on track and to prevent your portfolio from becoming too risky during market surges (like the one we've been experiencing in recent years) or too conservative after big market setbacks.
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