Rebalancing

What is 'Rebalancing'

Rebalancing is the process of realigning the weightings of a portfolio of assets. Rebalancing involves periodically buying or selling assets in a portfolio to maintain an original desired level of asset allocation.

For example, say an original target asset allocation was 50% stocks and 50% bonds. If the stocks performed well during the period, it could have increased the stock weighting of the portfolio to 70%. The investor may then decide to sell some stocks and buy bonds to get the portfolio back to the original target allocation of 50/50.

BREAKING DOWN 'Rebalancing'

While the term "rebalancing" has connotations regarding an even distribution of assets, a 50/50 stock and bond split is not required. Instead, rebalancing a portfolio involves the reallocation of assets to a defined makeup. This applies whether the target allocation is 50/50, 70/30 or 40/60.

Often, these steps are taken to ensure the amount of risk involved is at the investor's desired level. As stock performance can vary more dramatically than bonds, the percentage of assets associated with stocks will change with market conditions. Along with the performance variable, investors may adjust the overall risk within their portfolios to meet changing financial needs.

Rebalancing Retirement Accounts

One of the most common areas investors look to rebalance are the allocations within their retirement accounts. Asset performance impacts the overall value, and many investors prefer to invest more aggressively at younger ages and more conservatively as they approach retirement age. Often, the portfolio is at its most conservative once the investor prepares to draw out the funds to supply retirement income.

Rebalancing for Diversity

Depending on market performance, investors may find a large number of current assets held within one area. For example, should the value of stock X increase by 25% while stock Y only gained 5%, a large amount of the value in the portfolio is tied to stock X. Should stock X experience a sudden downturn, the portfolio will suffer higher losses by association. Rebalancing lets the investor redirect some of the funds currently held in stock X to another investment, be that more of stock Y or purchasing a new stock entirely. By having funds spread out across multiple stocks, a downturn in one will be partially offset by the activities of the others, which can provide a level of portfolio stability.

Rebalancing Frequency

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. Rebalancing gives investors the opportunity to sell high and buy low, taking the gains from high-performing investments and reinvesting them in areas that have not yet experienced such notable growth.

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