In order to have a disciplined approach using "rebalancing style" investing, you must first setup a defined model that specifies target asset allocation percentages for each asset class or securities for which you desire to invest funds. In our example, let's assume that you want to have 60% of your money in equities (considered a more aggressive investment) and 40% in fixed income (considered a conservative investment).You decide to allocate to these asset classes as follows:
30% in U.S. Equities
20% in International Equities
10% in Emerging Markets
20% in U.S. Bonds (shortterm)
20% in International Bonds (shortterm)
Now that you have determined your asset allocation, the hard part is over. Rebalancing is simple from this point, as you'll just need to set an acceptable allocation weight variance for the overall portfolio or each asset class individually. There are four common variance structures for rebalancing:
Fixed Rebalance Percentage
A predetermined fixed variance (per cent) is used for all asset classes. For example, a (+)/() 3% variance may be applied. So, if U.S. equities has a positive run up to 33%, then you would rebalance the asset class. If the percentage drops to 27%, you would add to the asset class from somewhere else by selling securities that have an elevated weighting.Specified Rebalance Percentage
In this case, you might assign a higher variance to the larger asset classes and a smaller variance to the smaller ones. For example, (+)() 5% to the larger asset classes and only (+)() 2.5% to the smaller classes. When the weights move beyond the desired variance, proper trades are executed to achieve the target allocations.Flat Dollar
You may decide to use a flat dollar benchmark, such as $5,000, instead of assigning a percentage. When the asset class grows past this amount, you rebalance and invest the funds elsewhere. If the value falls below the target amount, more funds have to be allocated to the investments. Proportionate Method
Here you would select a fixed percentage, say 20%, to be applied to each asset class individually. So, U.S. equities would be rebalanced at a (+) or () 6% variance (20% of 30), emerging markets at a (+) or () 2% (20% of 10) and so onâ€¦
Rebalancing is an important strategy to maintain a disciplined approach to investing. Allowing a specific asset or asset class to get too large or small within your portfolio can affect the overall risk, performance and weightings, which deviate from the original investment strategy. (For portfolio rebalancing tips, refer to Rebalance Your Portfolio to Stay on Track.)
This question was answered by Steven Merkel

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