Rebalancing is different from reallocation. Rebalancing is adjusting your portfolio through time to keep it in synchronize with your risk level. For example, say you're a moderately aggressive investor with an asset allocation of 80% stocks, 15% bonds and 5% cash. If the performance of your investments pushed that mix to 90% stocks and 5% bonds, you might sell some stocks and buy some bonds to bring those percentages back in line.
Reallocation means shifting to a new asset allocation plan that reflects an entirely different risk level. For example, an investor in his 30s may prefer an aggressive asset allocation with 95% stocks. But by the time he retires, he may switch to a moderately conservative approach with only 40% stocks.
Creating an asset allocation and investment plan and then rebalancing is a little like planting garden. Planting the seeds may be the first step, but without some important care along the way (watering, pruning) the desired results may not come.
In rising stock markets, people often take on more risk than they are suited for. We saw this in the last market cycle. In the late ‘90s, many investors fell in love with stocks and did not rebalance, consequently they ended up with a much larger percentage of stocks in their portfolios than their risk levels warranted. Many times, people only realize they have taken on too much risk when they experience the negative effects of that risk, when the market goes down. Many investors bought all the way up, and when the market started to come down, they realized they had taken on too much risk and sold on the way down, as a contradiction to the old “buy low, sell high” mantra.
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