Rebalancing
Trading a portfolio back toward its starting mix after market moves have shifted it.
Holdings that rise grow as a share of the whole, so a mix drifts without anything being bought or sold. A portfolio that starts at 60% stocks can end a strong decade for stocks nearer three quarters in them, carrying more risk than it started with.
Common approaches include rebalancing on a calendar, once or twice a year, and rebalancing only when a holding drifts past a set band, often around five percentage points. Directing new contributions toward whatever has fallen behind shifts the mix without selling anything.
The tradeoff is cost against drift. Selling in a taxable account can realize gains and a tax bill, while trades inside an IRA or 401(k) do not, and a portfolio that is never rebalanced ends up with whatever mix the market chose for it.
Worked through
A 60/40 mix left alone for ten years
Stocks returning 10% a year and bonds 3%, with nothing bought or sold.
- Stocks at the start
- $60,000
- Bonds at the start
- $40,000
- Stocks after ten years
- $155,625
- Bonds after ten years
- $53,757
The mix moved from 60/40 to about 74/26 without a single trade.
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