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1997-98: REVIEW AND OUTLOOK : Morningstar on Conventional

Rebalancing? Think of It as Preventive Medicine


It seems it never ends. Once you've set up a portfolio, conventional wisdom says, you're supposed to rebalance it--reevaluating annually, looking at what's gotten out of whack and shifting money away from the winners and toward the losers.

Guess what? Going through the hassle of rebalancing wouldn't have made a heck of a lot of difference to your portfolio's performance over the last two decades.

Nonetheless, rebalancing is a sound strategy and still may prove helpful. Think of it as preventive medicine--especially if the next 20 years are less kind than the last 20.

No doubt about it, the primary reason to rebalance is to protect yourself from a disaster. Over the last 20 years, a portfolio of 60% stocks, 30% bonds and 10% cash would have become a blend of 84% stocks, 13% bonds and 3% cash if left alone. Presumably, the investor who set up a 60-30-10 portfolio did so to reflect his or her goals and risk profile; the new portfolio no longer does. Rebalancing limits the stock exposure and deflates the portfolio's risk.

Unfortunately, returns can deflate at the same time. If a portfolio made up of 60% stocks, 30% bonds and 10% cash were rebalanced annually, compared with an unbalanced portfolio it would have lost about three-quarters of a percentage point per year over the last 20 years, assuming no transaction costs (no-load funds) and no taxes.

That's the story when stocks go up. History reminds us, however, that they don't always do that. An investor who rebalanced each year during the turbulent '70s would have outperformed the investor who didn't rebalance by roughly 0.4 percentage point per year over the 10-year period. But as long as stocks continue to go up more often than they go down, expect rebalancing to clip returns.

Lesson: Rebalance by asset class, lower your expectations a notch and keep repeating, "It's the risk, stupid."


Ready, Set, Rebalance

Steps for Rebalancing a Portfolio


Set target percentages for asset classes and styles based on goals and risk tolerance. (Strategies for determining these targets is a subject unto itself.)


At least once a year, check your portfolio's composition and recalculate percentage breakdown for various asset classes and styles.


Invest any new available money in the areas that have fallen the farthest from their targets, assuming your goals and risk tolerance haven't changed.


If any asset class is still seven percentage points (plus or minus) off its target, buy or sell shares to bring allocation back into alignment. If style breakdown gets out of line by plus or minus three to five percentage points, buy or sell shares to bring the portfolio back into balance. The cost of rebalancing is less with no-load funds or those with minimal transaction costs.


Pat yourself on the back, lower your expectations a notch and enjoy the restful nights.

Source: Morningstar Inc.



A portfolio of 60% stocks, 30% bonds and 10% cash would have grown to a mix of 84% stocks, 13% bonds and 3% cash if left untouched for the last 20 years.

Starting allocation 1977

Stocks: 60%

Bonds: 30%

Cash: 10%


Ending allocation 1997

Stocks: 84%

Bonds: 13%

Cash: 3%

Source: Morningstar Inc.

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