Rebalancing an investment portfolio is a crucial technique that helps investors maintain their desired asset allocation, especially after significant market fluctuations. Market downturns can skew the balance of stocks, bonds, and other assets, leading to increased risk or reduced returns. Here are three practical examples of rebalancing after a market downturn.
After a significant market drop of 20%, a conservative investor with a balanced portfolio of 60% stocks and 40% bonds finds that their allocation has shifted to 50% stocks and 50% bonds due to falling stock prices. They decide to rebalance to align with their risk tolerance.
To rebalance, the investor sells enough of their bond holdings to increase their stock allocation back to 60%. This involves selling 10% of their bonds and using the proceeds to buy stocks that are currently undervalued due to the downturn.
This approach allows the investor to capitalize on lower stock prices while restoring their desired risk profile. They should monitor their portfolio regularly to ensure it remains aligned with their investment goals.
An aggressive investor has a portfolio consisting of 80% stocks and 20% bonds. Following a major market downturn, their stock allocation has dropped to 70% due to falling stock values. They believe this is a buying opportunity and want to increase their stock exposure.
To rebalance, the investor decides to sell a portion of their bond holdings and invest the proceeds into additional stocks, bringing their stock allocation back up to 80%. This may involve selling 10% of their bonds to purchase growth stocks that have the potential for a rebound.
This strategy emphasizes taking advantage of market conditions to maintain a higher risk profile. Investors using this technique should be comfortable with market volatility and have a long-term investment horizon.
A target-date fund investor nearing retirement has a diversified portfolio that originally consisted of 60% equities and 40% fixed income. After a market downturn, their allocation shifted to 50% equities and 50% fixed income, deviating from their target allocation.
To rebalance, the investor sells some of their fixed-income assets and reallocates those funds into equities, achieving their target allocation of 60% equities and 40% fixed income once again. This process can be automated if the investor is using a target-date fund that manages rebalancing.
Target-date funds are designed to automatically adjust the asset allocation as the target date approaches. However, investors can still benefit from manual rebalancing after market downturns to maintain their desired risk exposure.
By applying these examples of rebalancing after a market downturn, investors can better navigate the complexities of market fluctuations and maintain their investment strategy effectively.