Professor Burton Malkiel of the Rebalance Investment Committee explains how rebalancing positively affects returns. More on rebalancing effectively.
Rebalancing simply means that you’ve got a particular asset allocation. And when market prices change and, therefore, your portfolio has a different mix than your preferred asset allocation, that you simply rebalance, that is to say, bring the mix back to your preferred allocation. And, again, this is a wonderful technique because it forces you to do just the opposite of the mistakes that people make.
For taxable accounts, I suggest doing it once a year because long-term capital gains are taxed at a lower rate than short-term capital gains and you’re usually selling the asset class that went up. If you’re in an IRA, you can rebalance more often and you could rebalance — instead of just doing it once a year, you could have a little trigger that says if you’re more than 5 or 10 percentage points away from your preferred allocation, do it. So there are many different ways of doing it. Whichever way you do it, and I’ve simulated many different ways to doing it, it’s a winner.