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.
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.
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.
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
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.