Between now and?the end of the year, you?ll hear lots of pundits and investment advisers urge you to?rebalance your portfolio. But is this almost universally recommended investment ritual?really worth the?time and effort?
The answer is yes, generally, but?not for the reason you may?think.
Why You Need to Rebalance
Rebalancing is simply a strategy?for restoring?your portfolio to the mix?of stocks and bonds that jibes with?your risk tolerance and?financial?goals.?If all investments moved in synch, there would be no need to do this. But that?s obviously not the case.
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Different?parts of your portfolio?almost always generate different returns, which means whatever?asset blend you originally set will?get knocked out of whack.
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For example, let?s assume that at the end of 2007, you had 80% of your portfolio invested in stocks and 20 percent in bonds. The next year, 2008, the Standard & Poor?s 500 index?got clobbered with a 37% loss, while the broad bond market?gained a bit over 5%.?So if you did?nothing but reinvest interest, dividends and any other distributions, by the end of 2008 your 80/20 blend?would have morphed to roughly 70/30, a considerably more conservative mix.
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To return?your portfolio to its original 80/20 proportions ? and get you back to the more aggressive investing strategy that matches your risk tolerance and goals ? you would rebalance.
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In this case, you would sell enough bonds to bring them?back down to 20% of your portfolio?s value and funnel the proceeds into stocks, pushing?equities back to their 80% share.
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When Rebalancing Isn?t Necessary
But the case for rebalancing isn?t always so clear cut, which is why I said it?s ?generally? worth the effort.
In 2011, for example, stocks gained a bit more than 2%, while bonds gained just under 8%. So a portfolio that started?the year with an 80/20 stocks/bonds mix would have ended with?79% stocks?and?21% bonds. Purists may disagree, but I?d say the two portfolios are effectively the same.
Rebalancing?could even be counterproductive?in such a case, since?transaction costs and (if you?re dealing with taxable accounts) taxes could outweigh any benefit. Besides, when a portfolio?s proportions are off by such a small margin, you may be able to bring them back in line by adding new money to the lagging investments over the course of the year, rather than selling assets.
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