A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

4. 
Rebalancing 
Can 
Reduce
Investment 
Risk 
and 
Possibly
Increase Returns
A very simple investment technique called rebalancing can
reduce investment risk and, in some circumstances, even
increase investment returns. The technique simply involves
bringing the proportions of your assets devoted to different
asset classes (e.g., stocks and bonds) back into the
proportions suited to your age and your attitude toward and
capacity for risk. Suppose you decided that your portfolio
ought to consist of 60 percent stocks and 40 percent bonds
and at the start of your investment program you divided your
funds in those proportions between those two asset classes.
But after one year you discovered that your stocks had risen
sharply while the bonds had fallen in price, so the portfolio
was now 70 percent stocks and 30 percent bonds. A 70–30
mix would then appear to be a riskier allocation than the one
most suitable for your risk tolerance. The rebalancing
technique calls for selling some stocks (or equity mutual

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funds) and buying bonds to bring the allocation back to 60–
40.
The table below shows the results of a rebalancing strategy
over the fourteen years ending in December 2009. Every year
(no more than once a year) the asset mix is brought back to
the 60–40 initial allocation. Investments were made in low-
cost index funds. The table shows that the volatility of the
market value of the portfolio was markedly reduced by the
rebalancing strategy. Moreover, rebalancing improved the
average annual portfolio return. Without rebalancing, the
portfolio returned 8.76 percent over the period. Rebalancing
improved the annual rate of return to 10.07 percent with less
volatility.