Most investors do not rebalance their investment portfolios in spite of the advantages of doing so. Research supports the benefits of regularly rebalancing a portfolio. We recommend investors start with a target investment allocation and then periodically sell or buy individual holdings in order to keep that allocation in balance.
For example, suppose an investor starts with 50% in stocks and 50% in bonds. A year later, the stock market has fallen, and the investor now has 40% in stocks and 60% in bonds. To rebalance, the investor would sell enough bonds and buy enough stocks to restore the original 50%/50% balance. Doing this forces the investor to sell something that has increased in value and to buy something that is now at a more reasonable price.
Unfortunately, perfectly rational individuals find it emotionally difficult to rebalance into investments that have declined in value. Not just individuals but also sophisticated institutional investors fail to rebalance. Much daily financial news and Wall Street investment advice encourages buying what is doing well and selling what is declining. This behavior overlooks that investment asset classes exhibit long-term mean reversion in prices. In plain English, periods of outperformance are followed by periods of under-performance and vice-versa.
Too frequent rebalancing can be counter-productive. Investments tend to have momentum when moving in one direction. An investor may end up selling a rising asset too soon. Therefore, investors should consider rebalancing their portfolio periodically at the same time during each year.
Let me encourage you to employ periodic rebalancing to enhance your long-term investment success. Avoid chasing returns. Avoid market predictions. Diversify and rebalance periodically for safety and success.
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