Personal Finance Essentials
The Importance of Rebalancing
A Critical Strategy That Helps You Maintain Your Desired
Investment Allocation and Manage Risk Over Time
Portfolio rebalancing is a critical strategy that helps you maintain your desired investment allocation and manage risk over time. This is vital, because when you’re diversified, some of your investments will be performing better than others at any given time – and that means your original portfolio mix will drift from your intended balance.
For example, say you start with just two assets, putting half your money into each. Over time, one will rise faster than the other – causing your 50/50 allocation to morph into 60/40 or 70/30. If left unchecked, the portfolio could eventually become 100/0, ruining the diversification you desired.
Rebalancing solves this problem. You simply sell some of the assets that have risen faster and buy more of the assets that have risen more slowly – or perhaps even fallen in value. This strategy overcomes the common emotional mistake of buying high and selling low. Instead, you do the exact opposite: you sell high and buy low, which is the very goal of every investor.
Overcoming the Emotional Barrier
Most investors struggle with rebalancing for a simple reason: buying an asset that has declined feels uncomfortable, and selling an asset that has been rising feels wrong. Research has found that investors often hesitate when faced with a rebalancing opportunity, held back by fear and discomfort.
The solution is to make rebalancing a systematic, rules-based process. Rather than deciding when to rebalance, you simply rebalance when a trigger point occurs – such as when your allocation drifts beyond a set threshold. Because there’s no decision to make in the moment, there’s no emotion involved. You sell high and buy low automatically, without second-guessing yourself.
Thus, rebalancing helps you: