In the investment world, rebalancing is the process of buying and selling your investment holdings to bring them back in line with your target allocation. Very simply, if your goal is to be 50% stocks and 50% bonds, and you check your portfolio and it is now 60% stocks and 40% bonds, then you will sell some stocks and buy some bonds to get your actual holdings in line with your goal.

The benefits of rebalancing are:

  1. It forces you to buy low and sell high based on the performance of your portfolio.
  2. It reduces the risk of your portfolio by keeping in line with your risk-based allocation, among other things.
  3. It helps instill investor discipline so that you do not sell low and buy high.

There are many opinions on how often you should rebalance. Some more complicated investment strategies benefit from rebalancing as frequently as monthly. The problem with rebalancing this frequently is that there are trading costs with each buy and sell, as well as taxes if in a taxable account. Most advisers recommend rebalancing at least annually as a good balance of gaining a benefit from the rebalancing while keeping costs and taxes down.

How frequently you should rebalance is based on how much you have invested, how much is in taxable versus tax-deferred accounts, and your investment strategy. A $7 trading fee a few times a month is not nearly as big a deal to someone with $1,000,000 in the market compared to someone with $1,000 invested, so rebalance less often if you are just starting out. If most of your assets are in tax-deferred accounts and if you have no-commission trades on the mutual funds or ETFs that you own, then you can rebalance more often, perhaps quarterly or semi-annually if there has been any substantial change in your accounts. If your assets are in taxable accounts or if your trading costs are high, then you should rebalance annually or only when your allocation has moved 2-3% or more off your target.

-Richard

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