|Course 305: Rebalancing Your Portfolio|
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 say that 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 to congratulate yourself. Your $20,000 investment had turned into more than $41,000.
Credit a lot of that success to the stock fund. Your 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% of your portfolio in late 2006. You decide not to mess with its winning streak.
By late 2008, however, you would've gone from patting yourself on the back to kicking yourself you know where. Your portfolio lost more 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 positions in the funds, you wouldn’t have lost half as much during that year. Rebalancing would have protected a sizable chunk of the gains you made with T. Rowe Price Growth Stock.
The upshot: No one investment style stays in favor forever. In the mid-1990s, for example, 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 high-quality bonds held up just fine.
And that's the whole point of rebalancing: You don't know what asset class, 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, protect your gains, and position your portfolio to benefit from a change in the market's favorites.
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