Rebalance Your Portfolio
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Your Long-Term Portfolio has target percentages for each fund and asset class. We start investing by placing those amounts in each fund so that we are perfectly balanced. The day you initially invest will be the last day you are perfectly balanced.
The components of your portfolio will move differently each day, throwing them off target. Rebalancing is simply the act of trading the portfolio to get it back on-target. It is too costly in both trading expenses and time and effort to always maintain exact balance.
Instead, use a tolerance around your target to indicate when changes should be made. When you do this, you’ll find that every trade you make moves you closer to your targets, even though you are unlikely to ever again be exactly on target.
Why Rebalancing is Important
If you don’t rebalance, you will be vulnerable to the biggest mistake you can make in investing. As markets rise, the riskiest part of your portfolio will do much better than the rest and it will become a larger and larger percentage of the whole portfolio. You not only become less diversified, but the velocity of your portfolio increases greatly as markets go up.
When the inevitable market crash comes, your portfolio will crash much harder and much faster than you imagined. This is because the percentages you have in risky investments has increased much greater than you originally wanted.
Your portfolio will not act as you expect and it will cause you to doubt the whole idea of investing. You might even commit the worst mistake you can make by selling out and waiting for a “better time” to invest in the future.
That never comes.
So instead of opening yourself up to this greatest of investment mistakes, make sure you have a disciplined process to rebalance your portfolio as it gets out of line with your original targets.