Investing is not a “set it and forget it” activity. While building a diversified portfolio is a crucial first step in your investment journey, maintaining that portfolio is just as important. Over time, market fluctuations can cause your portfolio to drift away from its original asset allocation, potentially exposing you to more risk than you intended. That’s where rebalancing comes in. Rebalancing is the process of realigning the weightings of the assets in your portfolio to maintain your desired level of risk and return. In this article, we’ll explore what experts like Scott Tominaga have to say about why rebalancing is essential, when you should do it, and how to go about it effectively.
Why Rebalancing Matters
When you first create your investment portfolio, you likely choose an asset allocation based on your risk tolerance, investment goals, and time horizon. For example, you might decide to allocate 60% of your portfolio to stocks and 40% to bonds. This allocation reflects your balance between the desire for growth (stocks) and the need for stability (bonds).
However, as time passes, market conditions change. If stocks perform well, they may grow to represent a larger portion of your portfolio—say 70%—while bonds shrink to 30%. While this might seem like a good problem to have, it actually means your portfolio is now more heavily weighted toward stocks, making it riskier than you originally intended.
1. Managing Risk
The primary reason for rebalancing is to manage risk. By periodically adjusting your portfolio back to its original asset allocation, you ensure that your risk exposure remains consistent with your goals. This helps you avoid taking on too much risk during bull markets and ensures that you’re not too conservative during bear markets.
Why It Matters: Over time, an unbalanced portfolio can drift significantly from your target allocation, exposing you to more risk than you’re comfortable with. Rebalancing keeps your risk level in check, helping you stay on track toward your financial goals.
2. Taking Advantage of Market Opportunities
Rebalancing also allows you to take advantage of market opportunities. When you rebalance, you typically sell high-performing assets and buy underperforming ones. This might seem counterintuitive, but it’s actually a smart strategy known as “buying low and selling high.” By doing so, you lock in gains from assets that have increased in value and invest in assets that may be poised for a rebound.
Why It Matters: Market timing is notoriously difficult, but regular rebalancing can help you capitalize on market cycles. It encourages disciplined investing by focusing on maintaining your desired allocation rather than trying to predict short-term market movements.
Rebalancing is a crucial aspect of maintaining a healthy investment portfolio. By periodically adjusting your investments to realign with your target asset allocation, you manage risk, take advantage of market opportunities, and stay on track toward your financial goals.
Whether you choose a time-based, threshold-based, or hybrid approach, the key is to remain disciplined and consistent in your rebalancing strategy. While it might be tempting to let your winners run or avoid selling during a downturn, rebalancing ensures that your portfolio remains balanced, diversified, and aligned with your long-term objectives.
In the end, rebalancing is about staying true to your investment strategy. By regularly reassessing and adjusting your portfolio, you can navigate the ups and downs of the market with confidence and keep moving steadily toward your financial goals.