Why Bother Rebalancing Your Portfolio?

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Why Bother Rebalancing Your Portfolio?

Rebalancing is primarily about risk control, or making sure your portfolio isn’t overly dependent on the success or failure of one investment, asset class, or style.

Here is an example

Let’s take a hypothetical example based on two anonymous funds: Say that you put $10,000 in ABC New Income Fund and $10,000 in XYZ Growth Stock Fund 11 years ago. Nine years later, you had to congratulate yourself. Your $20,000 investment had turned into more than $41,000.

Credit a lot of that success to XYZ Stock Fund. Your position in that fund had grown to more than $24,000 at the end of the period. ABC New Income, while no slouch itself, was just $17,000. As a result of that outperformance, XYZ Growth Stock soared to roughly 60% of your portfolio this year. You decide not to mess with its winning streak.

By late this year, however, you would’ve gone from patting yourself on the back to kicking yourself you know where. Your portfolio lost more nearly 20% over the two previous years. The culprit? XYZ Growth Stock, which, like most stock funds, lost nearly two thirds of its value in that two-year period, a vicious bear market for stocks. ABC New Income, on the other hand, made money during that period.

How you could have done better

If you had rebalanced your portfolio at the beginning of last year, re-establishing equal positions in the funds, you wouldn’t have lost half as much during that year. Rebalancing would have protected a sizable chunk of the gains you made with XYZ Growth Stock.

The upshot: No one investment style stays in favor forever. In the mid-1990s, for example, all investors cared about were financials stocks. Then from the late-1990s until March 2000, technology stocks were the "in" cocktail party chatter. After that, the hot investments were REITs, or real estate investment trusts. Information technology, biotechnology, and healthcare are the hot ones in the 2020s. Bonds were in vogue long after the bear market of 2007–2009. In the bear market, nearly all stocks were hammered, but high-quality bonds held up just fine.

And that’s the whole point of rebalancing: You don’t know what asset class, sector or investing style is going to rule the investment world next year, or how rapidly things might change. Rebalancing helps you reap the full rewards of diversification. Trimming back on a winner allows you to buy a laggard, protect your gains, and position your portfolio to benefit from a change in the market’s favorites.