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Why rebalance your portfolio?

Why rebalance your portfolio?
Rebalancing your portfolio is the only way to stay on track with targeted asset allocation. Asset allocation refers to the percentage of your portfolio that is held in various investments, such as 80% stocks and 20% bonds. Target Asset Allocation is the percentage you want to hold on each investment so that you are comfortable with the amount of risk you take while you are on the right track to earning the investment returns you need to achieve your goals, such as being able to retire at age 65. The more shares you own, the greater the risk you are exposed to Her, and the greater the volatility of your portfolio (the more its value changes with market fluctuations). But stocks tend to outperform bonds in the long run, which is why so many investors rely on stocks more than bonds to achieve their goals.

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When the stock market is doing well, the percentage of your portfolio dollar value that stocks represent will increase as the value of your stock increases. If you start setting aside 80% for stocks, for example, it might go up to 85%. After that, your wallet will be more risky than you intended it to be. The solution? Sell 5% of your equity holdings and buy bonds for money. This is an example of rebalancing.
Psychologically, when the market is performing well, you may struggle to restore balance. Who Wants To Sell Investments That Work Well? They might go up and you might miss it! Consider these three reasons:
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You may go down and then take more losses than you are comfortable with.
When you sell an investment that has performed well, you preserve those gains. They are real. It doesn't just exist on the screen of your brokerage account. And when you buy an investment that isn't performing well, you get a bargain. In general, you are selling at a high price and buying at a low price, which is exactly what all investors are hoping for.
Rebalancing usually involves selling only 5% to 10% of your portfolio. So, even if you are annoyed with the idea of selling winners and buying losers (in the short term), you are at least only doing so with a small amount of your money.
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Most of the time, you will sell stocks and rebalance into bonds. A study by Vanguard looked back over the years from 1926 to 2009 and found that for an investor who wanted to maintain a balance of 60% of stocks and 40% of bonds, there were only seven occasions during those years when maintaining the ideal target allocation involved a ratio Bond distractions at least 5% of the 40% target.

There is no need to rebalance, of course. The greater the weight of your portfolio in equities, the more likely your long-term returns will be. But it won't be much higher than if you had a more balanced asset allocation, and the additional volatility could cause financially harmful decisions, such as selling stocks at a loss. For a completely rational investor (which no one really does), it might make sense to own 100% of the equity. But for anyone with an emotional reaction to seeing their retirement account balance decline when the stock market struggles, keeping some bonds and rebalancing regularly is the best way to stay on track with your plan and achieve the best risk-adjusted returns over time.
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One of the times investors found themselves rebalancing from bonds to stocks was during the 2008 financial crisis. At the time, it might have seemed scary to buy stocks that were declining. But these stocks were mainly bought at a huge discount, and the long bull market that followed the Great Recession rewarded these investors nicely. Today, these same investors must continue to rebalance. If not, they would have had a lot of weight in stocks and would struggle more for what they need the next time the market goes down. Since the markets are cyclical, it is only a matter of time for the market's fortunes to be reversed, good or bad.

How often should you re-balance?
There are three frequencies with which you can rebalance your wallet:
According to a specific time frame, such as once a year at the time of tax.
Whenever the target asset allocation is skewed by a certain percentage, such as 5% or 10%.
According to a specific timeframe, but only if the target asset allocation skewed by a certain percentage (combination of options 1 and 2).
The downside to Option 1 is that you may waste time and money (in the form of transaction costs) re-balancing unnecessarily. There's really no point in rebalancing if your portfolio is just 1% out of alignment with your plan.
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Last Update : Sep 22, 2020 8:47 AM
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