What is Rebalancing?
What is rebalancing?
- Rebalancing prevents you from making the human behavioural mistake of buying high and selling low
Rebalancing example:
Let's start with the typical retirement portfolio of 60% bonds / 40% stocks.
$100,000 initial portfolio would be split into:
$60,000 in bonds and $40,000 in stocks
If at the end of the first month, stocks start falling and investors rush to the safety of bonds, your portfolio would now look like:
$65,000 in bonds and $35,000 in stocks
Some investors would sell stocks and buy more bonds to capitalise on the increased value of bonds.
However, to keep the risk/reward ratio consistent, you need to do the opposite and rebalance back to 60% bonds / 40% stock, which means selling some of the bonds and buying up stocks at a cheaper price.
This is the essence of rebalancing. It helps reduce the greed of chasing increasing values in stocks or bonds.
It takes away the human emotion of trading and replaces it with a mathematically based strategy.
Using the Rebalance Portoflio Tool with Interactive Brokers
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