Does this ever happen to you? You hear a finance term and nod your head along as if it’s old hat. Meanwhile, you make a mental note to google it later. I’ve even done that. But let’s be real, it sucks. So I’m on a mission to answer every one of your finance questions, even if you think it’s “too simple.” In today’s post I’m tackling one of those pesky terms: portfolio rebalancing.

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This one gets thrown around all the time. Articles tell you, “make sure you rebalance your portfolio at regular intervals.” Which I would totally do if I knew what rebalancing was.

For those on the fast track, I’ll give you the very short definition. Portfolio rebalancing is a periodic selling of assets that have gone up in value and buying of assets that have gone down in value so that you can return your portfolio to its original asset allocation.

Since that definition is probably still confusing, here’s the long version:

Portfolio rebalancing really starts with explaining asset allocation. Asset allocation is how you divide your portfolio amount between different types of assets – stocks, bonds, real estate, cash, etc. You decide the proportion of your total portfolio to put in each asset based on factors like your risk tolerance and time until you need the money. You can also sub-allocate within those assets. For example, within stocks you can allocate proportions to growth stocks and value stocks.

Not everyone does this allocation, but it’s a method many investors use. You’ll particularly find it in target date funds in your retirement account, which allocate between assets based on how much time you have left until retirement. For example, a 2025 target fund (meaning it’s meant for someone retiring in 10 years) will be less risky than a 2055 fund.

Portfolio reallocation is what happens when those portfolio targets get out of whack. For example, let’s say that a year ago you put $2,000 in your portfolio and split it 50/50 between stocks and bonds. But if in the past year the value of your stocks rose to $1,200 and the value of your bonds declined to $800, you’re no longer split 50/50 between the two.

What is portfolio rebalancingRebalancing is just the process of getting back to your original allocations after market fluctuations threw them off. So here, to get back to an equal split you need to sell $200 worth of stocks and buy $200 worth of bonds. And then you are rebalanced back to 50/50.

The idea behind rebalancing is that you set up your original allocations for a reason (i.e. if you are retiring soon you probably don’t want a ton of stocks) and you should stick to those allocations. The idea is also that you are selling what’s performed well to lock in your gain, and buying what has underperformed and therefore may be a better value.

“People” advocate that you rebalance at set intervals, such as every year around your birthday. To be honest, I’m not totally sold on rebalancing and this post is merely a definition, not a recommendation that you follow it. But I’ve gone on for long enough so I’ll save my opinions for a future post.

Hope that helped! If you have any other terms or concepts that you want me to define just shout them out in the comments or send me an email!

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