Portfolio Rebalancing: A Must for All Investors

This article is an excerpt from the Shortform book guide to "The Intelligent Investor" by Benjamin Graham. Shortform has the world's best summaries and analyses of books you should be reading.

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What is portfolio rebalancing? How does it work and why do you need it?

When you have an uneven split between stocks and bonds in your portfolio, it’s time to consider portfolio rebalancing. You’ll want to sell stocks and bonds to return to a 50/50 split.

Read more about portfolio rebalancing and the rebalancing strategy below.

Portfolio Rebalancing

What is portfolio rebalancing? Over time, as your investment values fluctuate, the proportion between stocks and bonds will deviate from your desired ratio. For example, if you start with $10,000 and a 50-50 split between stocks and bonds, over time you may end up with $6,500 in stocks and $5,500 in bonds, leading to a 54:46 split. At this time, you should “rebalance” your portfolio to return to 50-50. You can do this by selling stocks and buying bonds, or if you have more money to invest, you would buy relatively more bonds than stocks in this round of investment to return to a 50-50 split. This is called portfolio rebalancing, or a rebalancing strategy.

Here’s how rebalancing investments can help. You shouldn’t rebalance more frequently than once or twice a year. If you’re checking your investments on a daily basis and spending hours per week, you’re getting too involved to be a defensive investor, and your emotions will likely start ruling your decisions.

Dollar-Cost Averaging

If you have a lump sum of money, how would you invest it? Some investors, tempted to get higher than market returns, might choose to “time the market,” waiting until a market dip to invest. The very likely risk is that the investor turns out to be entirely wrong, either losing out on gains as the market rises, or mistiming the bottom. This is one method of portfolio rebalancing.

In contrast, Graham recommends dollar-cost averaging—split up the lump sum into multiple investments of equal amounts, distributed over a longer period of time (such as every month or quarter). This is a straightforward strategy that requires minimum thinking and emotional investment.

Graham argues for the psychological benefits of dollar-cost averaging: you remain emotionally detached from the swings of the market. Regardless of whether prices are up or down, you invest the same amount. 

Practically, this prevents you from overreacting in bad directions when rebalancing investments:

  • When the stock market crashes, most people become fearful about investing, yet this is the point at which stocks are cheapest. Dollar-cost averaging forces you to invest the same amount.
  • Likewise, in a strong bull market, you might be tempted to buy stocks at steep prices. Dollar-cost averaging prevents you from getting carried away and investing more than is wise.

Psychologically, dollar-cost averaging helps you avoid the delusion that you can predict the market. Zweig notes that your response to any investment question should be “I don’t know and I don’t care” when it comes to rebalancing investments.

  • Are technology stocks worth doubling down on? Is this hot new company worth investing in at its premium price? “I don’t know and I don’t care”—if you invest in mutual funds, they already capture a large part of most industries, and any hot company that succeeds will be a part of your portfolio soon enough. 
  • Is the stock market going to rise or fall in the next month? “I don’t know and I don’t care”—if it rises, your existing investments will capture that gain; if it falls, you will invest more later at a lower price.

(Shortform note: Dollar-cost averaging has been studied extensively, with both strong advocates and critics. Critics argue that it leads to subpar performance—in short, if the expected value of your investment is positive, then you should invest as early as possible to capture that expected value. Proponents of dollar-cost averaging suggest that, even if it doesn’t yield superior returns, it carries benefits in psychological ease and simplicity.)

Now that you know methods of portfolio rebalancing, you can make sure your portfolio continues to have good stocks and you can use your rebalancing strategy.

Portfolio Rebalancing: A Must for All Investors

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Carrie Cabral

Carrie has been reading and writing for as long as she can remember, and has always been open to reading anything put in front of her. She wrote her first short story at the age of six, about a lost dog who meets animal friends on his journey home. Surprisingly, it was never picked up by any major publishers, but did spark her passion for books. Carrie worked in book publishing for several years before getting an MFA in Creative Writing. She especially loves literary fiction, historical fiction, and social, cultural, and historical nonfiction that gets into the weeds of daily life.

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