Last year was a strong year for the markets, with the S&P 500 Index up almost 22% in 2017. The new year has started out strong as well with the Dow Jones Industrial Average hitting new highs so far in 2018 along with strength throughout the markets.
If you have just let your portfolio ride you’ve made some solid gains. However, your portfolio has likely strayed from its target asset allocation and you may be taking on more risk than you’d like. If you haven’t done so, this is a good time to consider rebalancing your investments. Here are 4 benefits of portfolio rebalancing.
Balancing risk and reward
Asset allocation is about balancing risk and reward. Invariably some asset classes will perform better than others. This can cause your portfolio to be skewed towards an allocation that takes too much risk or too little risk based on your financial objectives.
During robust periods in the stock market equities will outperform asset classes such as fixed income. Perhaps your target allocation was 65% stocks and 35% bonds and cash. A stock market rally might leave your portfolio at 75% stocks and 25% fixed income and cash. This is great if the market continues to rise but you would likely see a more pronounced decline in your portfolio should the market experience a sharp correction.
Portfolio rebalancing enforces a level of discipline
Rebalancing imposes a level of discipline in terms of selling a portion of your winners and putting that money back into asset classes that have underperformed.
This may seem counter intuitive but market leadership rotates over time. During the first decade of this century emerging markets equities were often among the top performing asset classes. Fast forward to today and they coming off of several years of losses.
Rebalancing can help save investors from their own worst instincts. It is often tempting to let top performing holdings and asset classes run when the markets seem to keep going up. Investors heavy in large caps, especially those with heavy tech holdings, found out the risk of this approach when the Dot Com bubble burst in early 2000.