Lessons for Young Investors: How and Why to Rebalance

Rebalancing can help instil a disciplined mindset, which is especially important and useful for new investors

Abby Woodham 4 April, 2013 | 6:23PM
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The primary function of rebalancing is to control risk. The varying performance of asset classes over time causes a portfolio to shift away from its target asset allocation. For example, riskier assets exhibit more volatility, but also tend to outperform safer investments. Over time, as their proportional share grows, the risk of the portfolio drifts away from the target. Rebalancing controls this risk by moving capital between investments to re-establish the target asset allocation.

Although it is a productive and relatively simple process, most investors don't rebalance.

Rebalancing also can boost return. In practice, rebalancing means selling high and buying low, which is a hallmark of disciplined investing. The long-term trend for the market is to go up, so pruning an outperforming asset class and shifting the capital into an undervalued asset class improves return. Rebalancing also can help investors in a down market. Research shows that when investments decline sharply in value, they are likely to produce high returns in the near future.

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About Author

Abby Woodham  is an ETF analyst at Morningstar.