If I were a betting woman, I’d bet that you’ve probably heard about the wealth building power of owning a well-diversified investment portfolio using multiple asset classes, designed to withstand the market’s inevitable roller coaster ride. Most people nod along with me when I talk about diversifying their portfolio. But then a lot of people stop nodding along when I talk about another important way to build wealth over time – and that is regularly rebalancing your account back to its intended risk tolerance of investments.
Before your eyes start to glaze over and you stop reading this article, give me just a minute to make my point. You’ve probably heard the sage advice to “buy low and sell high”. Of course, we all want to do that, right? But HOW exactly do we do that, when in the same breath, we’re also told to buy and hold since timing the market is a fool’s errand. It gets confusing fast. But drumroll please…that’s where rebalancing enters the picture.
Let me give you a quick example of how it works: let’s say you’re holding a mix of 70% stocks and 30% bonds, which suits your risk tolerance and investing goals. The stock market has gains that year, so the stocks increase in value relative to the bonds and your account’s value is now made up of 73% stocks and 27% bonds. Rebalancing simply means you’re going to sell 3% of your stock funds and buy 3% of your bond funds and you’re back to your 70/30 original mix. What did we just do? We sold high and bought low – just as we know is good for us.
Let’s flip it around and say that the markets are down for the year and now your account’s value is made up 67% stocks and 33% bonds. You sell 3% of the bonds and buy 3% of the stocks, and voila, you’re buying stocks low, when they’re on sale. No having to guess, or time the market, needed!
Rebalancing gives you an easy, unemotional way to implement a methodical buy low/sell high strategy. You can rebalance based on a time strategy or whether a certain percentage of the account has drifted, or a combination of both – there’s no right or wrong, as long as you’re rebalancing!
As you make your rebalancing decisions, don’t forget to consider transaction costs to buy and sell, and whether you might be tripping some capital gains or losses in non-retirement investment accounts as you make trades.
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