Hypothetical Example

Let's look at hypothetical example of just two assets: asset A and asset B which could be stocks, mutual funds or exchange traded funds. Historically asset A delivers higher returns but it also has higher volatility when asset B is more stable but delivers lower historical return.

Asset A & B

Now if we are Ok with periodic drops of 60% of asset A we can construct our portfolio with 100% of asset A. Which means when our portfolio is valued at $100,000 it might go down $40,000 or loss of $60,000. Not everybody can handle such volatility or patience sit through such periods. So what can we do? Instead of investing 100% in asset A we can put 50% in asset A and 50% in asset B and then it will look like chart below.

Asset A & B 50/50

We reduced portfolio drops to just 40% but at the same time we lost half of our returns. Can we do better? Let's keep the same 50/50 asset allocation but also add regular quarterly rebalancing.

Asset A & B 50/50 Rebalanced

So what do we get with rebalancing? We get higher return but what is more important we also get lower volatility or periodic drawdowns of only 25% instead of 40%. This is why asset allocation and periodic rebalancing helps you.

You can ask for help from your financial adviser/stock broker or you can just do it yourself using this free Online Portfolio Rebalancing Tool and a few minutes.

Markets Chart