In a previous blog, we discussed strategies of asset allocation. One important way to maintain a proper allocation of assets is through the tool of rebalancing.
Rebalancing is the practice of buying or selling assets in order to maintain a particular proportion of asset allocation in a portfolio. For instance, let’s say I want 60% of my assets in stocks and 40% of my assets in bonds. Since stocks often increase in value faster than bonds, I may eventually end up with 70% of my assets in stocks and 30% of my assets in bonds. I would then need to sell some of my stocks and buy more bonds in order to maintain the original proportion.
Assessing a portfolio for rebalancing should happen periodically, usually once a year. Periodic rebalancing allows the investor to maintain the same level of risk as the initial portfolio. Rebalancing not only applies to different types of assets, but also different individual stocks as well. If stock X does particularly well one year, an investor may sell some of it to buy shares in stock Y in order to maintain a diverse portfolio. Rebalancing can also be used to change asset allocation throughout one’s lifetime. Retirement accounts often invest more in stocks when a person is younger, and shift that money to more conservative investments as a person reaches retirement age.
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