There are many different theories and philosophies on how and how often one should rebalance his or her portfolio. Some theories suggest rebalancing should occur frequently, as much as once a week or quarter, others annually, and some say once a decade is sufficient. Still, other methods call for percentage bands to be placed around each asset class and when these bands are broken the portfolio should be rebalanced; this method is known as target or range rebalancing.
No matter what theory you subscribe to, rebalancing remains a fundamental part of long-term asset management and must be exercised. Portfolio rebalancing is a very simple concept. A portfolio’s target asset allocation is compared to its current allocation. It is then rebalanced so that the current assets are reset to the predefined target allocation percentages. The action of rebalancing is simply buying and selling shares to meet the target allocation.
Why is rebalancing your portfolio important? Rebalancing is crucial to the long-terms success of your portfolio for several reasons. One important reason to rebalance a portfolio is that it limits portfolio drift and maintains the initial risk/reward you sought to capture when choosing that particular portfolio. Take for example a moderate portfolio composed of 60% equity and 40% fixed income. As the market fluctuates over time the moderate portfolio’s equity holdings grow to 70% while the fixed income shrinks to 30%. This makes the portfolio more aggressive than originally intended. To ensure the portfolio remains at its target 60/40 allocation you must rebalance it periodically.
Asset allocation does not ensure a profit or protect against a loss. No strategy assures success or protects against loss.
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