Rebalancing: Discipline Beats Timing
Imagine your portfolio consists of 70% stocks and 30% bonds. After a strong market rally, stocks fall to 85% of your portfolio due to price gains. Your risk has significantly increased without you taking any active action. This is where rebalancing comes into play.
How Rebalancing Works
You sell the asset class that has performed well and buy the one that performed worse. - You act strictly anti-cyclically. - You take profits (sell high). - You buy cheaply (buy low).Two Methods
1. Time-based: E.g., once a year on December 31st. 2. Threshold-based: E.g., once your stock allocation deviates by more than 5%.Conclusion: It automatically disciplines you and reduces your risk.