Rebalancing: The Key To Investment Success

Is your investment portfolio in balance? Are you rebalancing it every year to make sure your investment mix is positioned to meet your financial goals?

Here’s how rebalancing works and why it’s so important.

A Balanced Portfolio

In very simple terms, keeping your investments balanced means shifting funds among different asset classes.

Let’s say that your portfolio, based on your age, goals, and risk tolerance, should be:

60% equities

30% bonds

10% cash

Because of market fluctuations, at the end of the year (or whenever you rebalance), the value of your stocks has dropped, while the value of your bonds has increased. Or possibly the value of your stocks hasn’t gone up as much as your bonds. Your portfolio is now:

55% equities

40% bonds

5% cash 

To rebalance your portfolio, you need to sell some of your bond holdings, invest some of the proceeds in equities, and park some in your cash account.

This may seem counter-intuitive. You might think, “My bonds are doing great. My stocks, not so much. I should sell stocks and buy bonds, not the other way around.”

Why Counter-Intuitive Makes More Sense

On the surface, it might make sense to pour more of your money into the asset class that’s doing the best. History shows that for long-term investors, that strategy will hurt, not help, returns.

Why? Because by selling stocks that have declined in value, and using the proceeds to buy bonds that have increased in value, you’re selling low (stocks) and buying high (bonds). That’s the opposite of what you should be doing.

Instead, if you sell some of your bond holdings that have increased in value, you’re selling when those holdings are at a high value. Using that money to beef up the amount of equities in your portfolio means that you’re buying stocks at a discount. You’re buying low (stocks) and selling high (bonds), which is always the key to investing success.

Not only does this approach ensure that you’re buying low and selling high, it also eliminates the temptation to time the market. Since we can’t consistently predict when an asset class, such as bonds, has peaked, it’s impossible to know the optimum time to sell an asset and maximize profits. But by rebalancing your assets at least once a year, you’ll be taking advantage of the market.

You’ll also be keeping your portfolio in line with your long-term goals, which keeps your strategy in balance with those goals.