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What exactly does rebalancing entail? Does it mean that if I originally had 50% in stocks and 50% in bonds and my stocks do amazingly well that I end up with 75% in stocks and 25% in bonds that I need to move money around to put it back at 50%/50%?

What are the benefits of doing this?

How often should it be done?

Anything else I should know about it?

  • @CrimsonX Sorry, I need a dashboard to manage all of these SE sites that I forget to do things like that. Just fixed that. – Bryan Denny Aug 27 '10 at 17:22
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Rebalancing a portfolio helps you reduce risk, sell high, and buy low.

I'll use international stocks and large cap US stocks. They both have ups and downs, and they don't always track with each other (international might be up while large cap US stocks are down and vice-versa)

If you started with 50% international and 50% large cap stocks and 1 year later you have 75% international and 25% large cap stocks that means that international stocks are doing (relatively) well to large cap stocks.

Comparing only those two categories, large cap stocks are "on sale" relative to international stocks. Now move so you have 50% in each category and you've realized some of the gains from your international investment (sell high) and added to your large cap stocks (buy low).

The reason to rebalance is to lower risk. You are spreading your investments across multiple categories to manage risk. If you don't rebalance, you could end up with 95% in one category and 5% in another which means 95% of your portfolio is tied to the performance of a single asset category.

I try to rebalance every 12 months and usually get it done by every 18 months. I like being a hands-off long term investor and this has proven often enough to beat the S&P500.

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    In addition to risk reduction, it's also likely (but not guaranteed) there will be a rebalancing bonus to the overall portfolio rate of return, if the underlying asset classes exhibit sufficient uncorrelated behavior. – Chris W. Rea Aug 27 '10 at 16:48
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Rebalancing your portfolio doesn't have to include selling. You could simply adjust your buying to keep your portfolio in balance. If you portfolio has shifted from 50% stocks and 50% bonds to 75% stocks and 25% bonds, you can just only use new savings to buy bonds, until you are back at 50-50. Remember to take into account taxes if you are thinking of selling to rebalance in taxable accounts.

The goal of rebalancing is to keep your exposures the way that you want them. Assuming that you had a good reason to have a portfolio of 50% stocks and 50% bonds, you probably want to keep your portfolio similar in the future. If you end up with a portfolio of 75% stocks and 25% bonds due to stock market fluctuations, the exposure and the risk / return profile of your portfolio will have changed, and it's probably not something that you want.

You don't want to rebalance just for the sake of rebalancing either. There can be costs to rebalancing (taxes, transaction fees, etc...) and these aren't always worth the effort. That's why you don't need to rebalance every month or if your portfolio has shifted from 50/50 to 51/49.

I take a look at my portfolio once a year, and adjust my automated investments so that by the end of the next year I'm back to the ratio I want.

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    A good point about rebalancing possibly being just a change to buying habits in order to bring the portfolio back inline with the desired asset distribution. – George Marian Aug 27 '10 at 20:20

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