Rebalancing

Many investors react to wild, crazy headlines. Oil price drops and you freak out because there is some Exxon Mobil in your portfolio. A weak jobs report comes out or a scary inflation prediction from the Federal Reserve. What should you do? Generally, nothing. Certainly there may be some poeple out there who can profit off of this information, but I expect they are not reading RewardBus's Rebalancing page for investing tips. In the majority of scenarios, you are only hurting yourself by overreacting to miniscule events, which are often overblown by the media.

But, on the other hand, you do need to keep your portfolio balanced. Let's take a hypothetical example. You are comfortable with a 20% bond, 80% stock portfolio on 1/1/2015. In 2015, your bonds go down 40% and your stocks go up 10%. Now, your portfolio is 12% bond, 88% stock. This is higher risk than you feel comfortable doing! In this case, I would recommend rebalancing.

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What is the Desired Effect of Rebalancing?

Rebalancing is just a way to keep your portfolio in line with what risk you are comfortable with. As the markets fluctuate, your proportions will ebb and flow back and forth as there become winners and losers. Generally, what it means in practice is that you are going to sell your winners and buy your losers. This may seem counter-intuitive to some, but consider it as another reinforcement that you are buying low (losers) and selling high (winners). One other thing to note is the cash balance that grows from your dividends. Often, if you have many funds, stocks or bonds that pay dividends, if you aren't automatically reinvesting them they will build a large cash portfolio. It is important to continue to put this cash back at work.

How Often Should I Rebalance?

This question is difficult to answer definitively but I have found once a year is a roughly good timeframe. This question is similar to the one about how often you should check your balance. The more you do it, the more you are likely to make a mistake and overfit some reaction to a short-term event. Once a year provides enough time for things to get out of whack and most funds that ave a dividend will have it on at least an annual basis. This means all the cash will be settles, all the prices will have moved and you are set to rebalance your asset allocation. I also like rebalancing every year because I track both my net worh and my asset allocation target by age. Since you are doing it every year, you are able to adjust the risk you are taking annually: perhaps you want to add 1% bonds every single year until you retire.