An investment portfolio is just a set of assets, typically securities like stocks and bonds, and cash, but it can also include real estate, commodities, etc. What’s inside your portfolio, or in other words, what your asset allocation mixes are, depends on your own risk tolerance, which depends largely on your age and financial goals.
Rebalancing
Rebalancing is about restoring your portfolio back to the asset allocations that you originally intended for it to be at.
For example, if you had a 50/50 split between stocks and bonds, and after a year, due to the differing gains/loss that split becomes 60/40, then rebalancing involves bringing it back to 50/50. If you were to not rebalance, then you’d be more affected by a stock market crash.
You accomplish rebalancing by:
- Buying more of the underperformer (called accumulation).
- Selling the overperformer (called distribution).
- Also note that selling realises capital gains, which is less tax efficient because you no longer can earn compounded money on the would-be delayed tax payment.
Mr. Bogle points to research Vanguard has done comparing stock and bond portfolios that were annually rebalanced and those not rebalanced at all. The results show the rebalanced portfolios outperformed buy by a margin so slight it can be attributed to noise as much as the strategy. His conclusion: “Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio.” — The Simple Path to Wealth.