Left alone, a portfolio can drift from its intended allocation, possibly making it more difficult to reach your goals. That’s where rebalancing comes in.
Imagine sitting in a rowboat and wanting to get back to shore. If you just sit there, the wakes from passing boats and the wind could cause you to drift further toward the middle of the lake — not where you want to be. Of course, they might actually move you toward the shore. Who knows?
On the other hand, you could use your paddles. It’s more work, but it’ll increase the possibility of your reaching your destination.
It’s similar with your portfolio. If you neglect it, market activity may cause it to drift away — possibly far away — from where you want it to be.
Take, for example, a portfolio that starts out 60% stocks/40% bonds. If stocks were to have a particularly good year and bonds a bad one, the allocation could shift to, say, 70% stocks/30% bonds without the investor even realizing it. While this portfolio likely has better growth potential than the original, it could also take a bigger hit if stocks, which tend to be more volatile than bonds, turn around and have a bad year.
To help avoid this, you should periodically “rebalance” your portfolio by looking at how you’re diversified across different types of investments and making adjustments when necessary to bring it back to the asset allocation you originally intended.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.
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