Rebalancing: The Secret to Always Buying Low and Selling High

Everyone knows the old adage: buy low, sell high. Making a profit in the stock market sounds easy with that pithy phrase, but unfortunately it’s not as simple to accomplish as it sounds. How do we know what is “high”? Should I sell now, or wait for it to go higher? What about “low”? Stocks have fallen, but is it time to buy? What if they fall farther?

Enter “rebalancing.” Rebalancing is a technique which guarantees you will buy low and sell high. Sound magical? It’s actually very simple.
What is rebalancing?
At its core, rebalancing is selling some of your assets and purchasing others. The key to rebalancing is finding an asset allocation that works for you. Consult your financial advisor, or do your due diligence, and decide how you want to allocate your portfolio. 
There are many things one might invest in, from stocks to bonds to real estate to commodities and more. Let’s take a simple portfolio with a mixture of stocks and bonds. Some more aggressive investors will hold more stocks, while a more conservative investor may hold more bonds. Let’s say you are a typical investor who desires moderate growth, so you have set your asset allocation to a mixture of 60% stocks, 40% bonds, totaling 100% of your portfolio. Okay, so you’ve got your asset allocation set, now how do we go about “rebalancing”? 
In essence, over time the percent you have in stocks and bonds will shift based on how those assets perform. When stocks perform better, they become worth more, and consequently they become a larger percentage of your portfolio. Let’s say the value of the stocks now take up 70% of your portfolio. The bonds, which have stayed flat or underperformed, are now a smaller percent, only 30%. Your asset allocation is out of balance for your desired 60% / 40% balance. What do you do? Rebalance by selling the over performing asset and buying the under performing asset.

By selling the stocks, you are <i>selling them when they are high.  And by buying the bonds in this situation, you are <i>buying them when they are low.
If the stocks continue to go up, rinse and repeat. Are you selling at the absolute peak? No. But you are selling at a profit, and buying the other asset at a discount. Now let’s say the market shifts and stocks underperform for awhile. Suddenly, having dropped in value, they are only worth 50% of your portfolio while bonds are worth 50%. Again, you are out of balance. Sell some of those bonds (high), while buying the stocks when they are low (they have just dropped in price) to hit your target asset allocation again. 
As you can see, rebalancing is a powerful way to make sure your portfolio is always clicking and that you are managing to buy low and sell high without trying to game the system. We’ve managed to make that old phrase easy to accomplish after all!