REBALANCING is the strategy of setting target percentages for your various portfolio holdings. Thereafter, you would occasionally do some buying and selling, to bring your investment mix back into line with your targets. That can potentially allow you to take advantage of market declines. Elsewhere, we discuss rebalancing at greater length.
How does rebalancing look mathematically? Suppose you have your money divided equally between two investments, A and B. Investment A loses 20% this year, but gains 25% next year, which gets it back to even. Investment B does the reverse, making 25% this year and losing 20% next year, which means it also ends up with no gain.
What if you rebalanced at the end of the first year, which would involve shifting money from B to A, so you started the second year with an equal sum invested in both investments? Instead of finishing the two-year stretch with no gain, you would notch a return of just over 5%.
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