Rebalancing is an investing strategy to keep your investments in line with your original intentions as the markets move up and down. To rebalance your account, you buy and sell your assets every so often to keep the same weighting (percentage) in the funds as you originally requested.
Rebalancing is best explained using an example.
Let's say you decided to invest 40% of your assets (money) in bond funds and the remaining 60% in stock funds. Three months after your initial investments, you check your balance and you're now invested 30% in bond funds and 70% in stock funds. This movement from your original asset allocation is a result of the market movement over that time period. Rebalancing is the act of selling some of your bond investment and buying more of your stock investment to bring your assets back to 40% and 60% respectively.
Over time, an account that isn't rebalanced may not be properly aligned with your long-term goals and your tolerance for risk. Going back to the example, an account invested 30% in bonds and 70% in stock funds is more aggressive than the original investment. This new allocation, if it isn't rebalanced, will go against your initial asset allocation.
Buying and selling in this manner will also help you to focus on buying low and selling high, an investment strategy that some investors find hard to follow.
Rebalancing is best done on a regular schedule, two to four times per year.
Many find it helpful to use their quarterly statements as a reminder to trigger a rebalance. Check with your provider, as some plans offer rebalancing automatically within a retirement account.
Rebalancing in a retirement plan will not trigger a taxable event. If you are investing in a taxable account, consult with a tax adviser before making changes.