Having a mix of uncorrelated asset classes in your portfolio tends to protect the portfolio from downturns and to limit the gain from upturns in any asset class. Asset rebalancing is a powerful tool to improve your overall results.
Most financial planners recommend rebalancing annually. Others have data showing portfolio gains are higher when it is done less frequently – every two or three years. Yet another recommendation I’ve seen is to set gain or loss targets and rebalance only when one of the targets is attained.
Whatever rebalancing frequency is used, the act of rebalancing is the same. You choose an allocation percentage in advance for each asset class and, when you rebalance, you sell enough of the class that is above target to bring its actual portfolio percentage back to its target.
On the other side of the transaction, you buy enough of the classes that are below target to bring their portfolio percentages back up to target. For a portfolio in which you’re still investing new money, you can rebalance by buying only the asset classes that are below target.
When you periodically rebalance, you systematically sell investments that are up in value while their prices are high; and you systematically buy more of the classes that have declined in value while their prices are low.
The old truism is that the essence of investing is to buy low and sell high. Unfortunately, most people don’t have the self-discipline to execute that advice. Plus, nobody knows when the price has stopped going up until it goes back down. Nor do they know when the price is hits bottom until it goes back up. Consequently, most people invest by emotion and often buy high and sell low.
Asset rebalancing makes the “buy low, sell high” discipline much easier to live; you just move the money from one asset class already in your portfolio to others using pre-set rules for the transaction timing and amounts.
I’ve seen data that indicate regular rebalancing over many years increases the final portfolio value by 30% to 100%.
Asset rebalancing improves your investing results in a portfolio of uncorrelated asset classes.
Links to other Topics in the Special Report: Asset Allocation