(LifeWire) - Once you have settled on the right assets for your retirement portfolio, you must rebalance it regularly to keep those assets in the right proportions. Rebalancing your investments is the single most important thing you can do to ensure long-term success.
What Is Rebalancing Your Investments?
Rebalancing involves selling some of your recent big gainers and buying some of your most-recent losers. The goal is to bring your total portfolio back into the proportions you and your investment adviser have decided is best for you.
If you are a fairly young investor with 80% of your portfolio invested in stocks and 20% in bonds, you'll want to keep those proportions roughly fixed until your life condition changes. That's until, for example, you get closer to retirement and decide to bump up your proportion of bonds for safety.
You want that proportion to be set by you, and not by the market. And that's where rebalancing comes in.
Let's say that our 80-20 investor's stock portfolio takes off and gains 25% in a single year, while the bonds remain flat. At the end of a year, stocks would account for more than 83% of the portfolio's value, and the bonds would account for slightly less than 17%. To rebalance, our investor would sell enough stocks and buy enough bonds to get the whole thing back on an 80-20 split.
Benefits of Rebalancing Your Investments
Look closely at what happens when you rebalance: you sell assets when they are high, and you buy when they are low. That's the classic investment advice that is decidedly difficult to follow if you try to make yourself do it outside the discipline of a predetermined system.
Most advisers recommend that you rebalance at least once a year.
Rebalancing and dollar cost averaging
Rebalancing can be particularly powerful when used in conjunction with dollar cost averaging, a practice that involves dribbling a set amount of money into a portfolio at regular intervals. The classic example of a dollar cost averaging program is a 401(k) or any other form of payroll deduction investing: a set amount of money is pulled from each paycheck and invested in predetermined ways, regardless of market conditions.
Dollar cost averaging is a fairly effective tool for buying investments at the lowest prices, because more shares are purchased when prices are down than when they are high. When combined with rebalancing's requirement to sell the biggest gainers, the buy low, sell high strategy is doubly enforced.
