Rebalancing to Help Reduce Risk
What if there were a way to consistently buy low and sell high? As it happens, there is—if you take a disciplined approach to rebalancing your portfolio.
Because some of your holdings will invariably do better than others as the market rises and falls, your portfolio can drift away from its target asset allocation over time. If you commit to regularly selling assets that have become overweighted in your portfolio and buying those that have become underweighted, you’ll effectively be buying low and selling high.
Unfortunately, many people do the opposite. “When you have new money to invest or are making changes to your portfolio, the common urge is to put more money into the stocks or funds that have been doing the best recently,” says Mark Riepe, head of the Schwab Center for Financial Research. “Instituting a disciplined rebalancing strategy can help remove those emotions from the decision-making process.”
Practically speaking, you can approach rebalancing in a number of ways. Some people like to follow a strict schedule, realigning their portfolio to their target asset allocation monthly or quarterly. Others—including Mark—find it more useful to set a threshold past which it’s time to act.
“One approach would be to use a five-percentage-point departure in any one area of your target allocation as a prompt to rebalance,” he says. For example, if your target allocation calls for 60% stocks, you might choose to rebalance when that allocation rises to 65% or falls to 55%.
However you choose to approach rebalancing, the important thing is to have a reasonable rule—and to stick to it, regardless of what the market is doing.