Why Bother with Rebalancing?

Rebalancing is primarily about risk control, or making sure your portfolio isn't overly dependent on the success or failure of one investment, asset class or style.

Let's use a historical example. Let's say you put $10,000 in T. Rowe Price New Income PRCIX and $10,000 in T. Rowe Price Growth Stock PRGFX in January 1997. At the end of 2006, you had reason to congratulate yourself. Your $20,000 investment had turned into more than $41,000.

Credit a lot of that success to the stock fund. The position had grown to more than $24,000 at the end of the period. T. Rowe Price New Income, while no slouch itself, was just $17,271. As a result of that outperformance, T. Rowe Price Growth Stock soared to roughly 60% your portfolio in late 2006. Let's say you decided not to mess with your portfolio's winning streak, so you didn't rebalance.

By late 2008, you would've gone from patting yourself on the back to kicking yourself. Your portfolio lost more than nearly 20% over the two previous years. The culprit? T. Rowe Price Growth Stock, which, like most stock funds, lost nearly two-thirds of its value in that two-year period, a vicious bear market for stocks. T. Rowe Price New Income, on the other hand, made money during that period.

If you had rebalanced your portfolio at the beginning of 2007, re-establishing equal weightings between the funds, they wouldn't have lost half as much in 2008. Rebalancing would have protected a sizable chunk of the gains you made with the T. Rowe Price Growth Stock.

The upshot: No one investment style stays in favor forever. In the mid-1990s for example, it seemed all investors cared about were financials stocks. Then, from the late-1990s until March 2000, technology stocks were the 'in' cocktail-party chatter. After that, the hot investments were REITs, or real-estate investment trusts. Bonds have been in vogue ever since the bear market of 2007-2009. In the bear market, nearly all stocks were hammered but some high-quality bonds tended to hold up.

And that's the whole point of rebalancing – you don't know which sector or investing style is going to rule the investment world next year or how rapidly things might change. Rebalancing helps you reap the full rewards of diversification. Trimming back on a winner allows you to buy a laggard, help protect your gains and position your portfolio to benefit from a potential change in the market's favorites.

Read Next: How to Rebalance

Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Market volatility, volume, and system availability may impact account access and trade execution.

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