Portfolio Management April 16, 2015

    "Rebalancing" is the practice of selling "winning" investments and buying "losing" investments to return your portfolio to its target allocation if it has strayed too much from that target. It's another one of those "good financial hygiene" practices that not enough people embrace—and that Schwab Intelligent Portfolios™ performs automatically.

    Here's what can happen if you don't rebalance. Should one asset class gain in value while the other classes remain flat or lose value, the gaining asset class could eventually exceed its target or the other classes could fall short.

    So why not let winners continue to grow? And, conversely, why would you want to invest more in asset classes that aren't doing so well?

    Let's see what might have happened to a portfolio that wasn't rebalanced over the years before and after the 2008 financial crisis.

    Failure to balance can increase volatility over time

    Source: Schwab Center for Financial Research with data from Morningstar, Inc. Asset class allocations are derived from a weighted average of the total monthly returns of indices representing each asset class. The indices representing the asset classes are the S&P 500 Index (stocks) and the Barclays U.S. Aggregate Bond Index (bonds). Returns assume reinvestment of dividends and interest. Indices are unmanaged, do not incur fees and expenses, and cannot be invested in directly.

    If your portfolio was originally allocated 60% to stocks and 40% to bonds, your stock allocation would have shrunk to 40% by February 28, 2009—no surprise, given the substantial decline in the stock market over that time. But that would have left you less equipped to take advantage of the stock market turnaround that began one month later, in March of 2009. In other words, if you'd let your "winning" bonds ride during the credit crisis, you would have lost recovery potential.

    Rebalancing maintains the level of risk you want in your portfolio. It also adds discipline to your investing, forcing you to "buy low, sell high." You're not just paring back the asset classes that have outgrown their allocation ("selling high")—you're also buying more of the asset classes whose share of your allocation has shrunk.

    Maintaining that discipline can be difficult, because it's natural to want to keep a stock that's performing well. But buying low means buying more of your portfolio's poorest performers. And by staying diversified across a variety of asset classes rather than just piling into the flavor of the month, you're managing portfolio volatility and your exposure to risk. In other words, rebalancing may not maximize the dollar amount in your account in the short-term—but it can help ensure you have a long-term investment strategy that you can live with.

    Like many forms of financial discipline, rebalancing can feel like a chore and an emotional challenge. Fortunately, Schwab Intelligent Portfolios rebalances automatically, so you don't have to invest the time or overcome your natural reluctance to let go of outperforming investments, or buy underperforming ones.

    Rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.


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