Say that you originally constructed a portfolio of 60% stocks, 30% bonds, and 10% cash. If left alone over a 20-year period, that portfolio could easily morph into a blend of 84% stocks, 13% bonds, and 3% cash, just because some asset classes will grow faster than others. Presumably, you set up your original allocation to match your needs and your risk tolerance. If neither has changed--or if your asset-allocation parameters have actually gotten more conservative, as is usually the case as people get closer to retirement--your new allocation will be out of sync with your targets. If stocks dominate your portfolio (as they did in our example), your returns may rise but so will your risk. Moreover, you may find yourself with insufficient cash on hand to meet short-term needs. The only way to return the portfolio to the original stock/bond/cash mix is by buying and selling funds until you reach your original allocation. That's what rebalancing is.
Our Rebalancing Principles >>