It's a little bit counterintuitive to sell off your winners and buy more of the losers. But for investors with strategic asset allocation plans, rebalancing can boost returns over time.
Most people plan to buy low and sell high. Throw some fear and greed into the mix and that plan goes out the window. With regular rebalancing investors have a process to sell or reduce purchases of investments that have done well in addition to buying more of lagging sectors or asset classes.
In "Rethinking Rebalancing" from the November 2010 edition of Financial Advisor Magazine, writer James Picerno illustrates how rebalancing can improve a portfolio's returns by 50 basis points.
From the article:
"One strategy starts with the 60/40 mix and lets it run untouched over 10 years. The other portfolio is identical in the beginning except that it's rebalanced back to the original 60/40 allocation every Dec. 31. As Figure 1 shows, the rebalanced portfolio earned roughly 50 basis points a year more than its unmanaged counterpart for the decade: 3.9 percent versus 3.4 percent, based on annualized total returns."
Market movements over time can skew your asset allocation mix leading to an overbalance in one area, while poorer performers shrink. For instance, a portfolio containing equities and bonds could become overweighted toward one side over time, changing the risk profile of the portfolio.
Similarly, asset classes within the broad divisions of stocks and bonds can become bloated and start to dominate your portfolio. Keeping your portfolio diversified and sticking to your plan mitigates risk.
According to the SEC guide to asset allocation:
"By rebalancing, you'll ensure that your portfolio does not overemphasize one or more asset categories and you'll return your portfolio to a comfortable level of risk."
Some investors choose to rebalance once a year by the calendar. With so much financial housekeeping to be done at year's end, now may be as good a time as any to rebalance your portfolio if it's been neglected for more than a year.
Of course, selling investments can have tax consequences so check with your investment adviser when in doubt.
Use Bankrate's asset allocation calculator to start building a balanced portfolio.
How often do you rebalance? How do you determine when to do it?