Rebalancing is the art and science of adjusting the weightings of assets within a portfolio. The goal is to maintain the original or desired level of asset allocation or risk. Here’s an example:
Suppose an investor has 50% of their portfolio in stocks and 50% in bonds. If stocks performed well during the period, it could have increased the stock weighting of the portfolio to 70%. The investor may then decide to sell some stocks and buy bonds to get the portfolio back to the original target allocation of 50/50.
Additionally, rebalancing gives investors the opportunity to sell high and buy low. An investor may, for instance, realize gains when certain positions increase in value and reinvest those gains to reduce the average cost of other investments.
"Averaging down" or "buying on dips" is a common strategy used by many investors. Basically, this consists of reducing the average cost of an investment in a stock you own by buying more of that stock at a cheaper price. This tends to increase the investor's returns if the stock's price rises (which is not guaranteed, however).
Portfolio rebalancing may be an interesting strategy for short-term and long-term investors alike - albeit the frequency of rebalancing may vary from one investor to another, depending on their particular approach.
Ultimately, the ideal frequency of rebalancing depends on the desired level of asset allocation or risk. An advantage of calendar rebalancing (rebalancing the portfolio on predetermined dates) is that it tends to be less time-consuming, since it's a more passive approach based on fixed schedules. More active investors, on the other hand, may focus on the allowable percentage composition of an asset in a portfolio, using target weights and tolerance ranges to guide their trading.
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Diversification and/or asset allocation do not ensure a profit or protect against loss.
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