Investing

Rebalancing | Vanguard

Your target asset mix vs. your current mix

Target asset mix

Your investment goal, time frame, and risk tolerance determine your target asset mix, which is the ideal mix of stocks, bonds, and cash you should hold in your portfolio. Once you determine your target asset mix, you can open an account and select investments.

Your target asset mix is all about what’s going on in your investing life—what you want to accomplish and what makes you feel comfortable. Market movements and current economic conditions don’t affect your target asset mix.

Most investors’ target asset mixes remain generally consistent, but it’s important to reevaluate your target if you experience a significant change in lifestyle—like having a child, changing jobs, or retiring.

Current asset mix

Your current asset mix is the actual mix of stocks, bonds, and other investments you hold in your portfolio at any point in time. Unlike your target asset mix, market movements and current economic conditions can affect your current asset mix. Although it may initially look identical to your target asset mix, your current asset mix can drift from your target over time as stocks and bonds fluctuate in value.

The case for rebalancing

When one asset class—stocks, for example—is performing better than another, your portfolio may become “overweight” in that asset class. Say your target asset mix is a 50/50 split between stocks and bonds. You originally invest $3,000 in a stock fund, which buys 20 shares. You invest another $3,000 in a bond fund, which also buys 20 shares. Your $6,000 portfolio balance is split evenly between stocks and bonds, matching your target.

Fast-forward several months in which stocks have consistently outperformed bonds. For simplicity, let’s say you don’t reinvest your dividends or capital gains or make any additional contributions, so you still own 20 shares of each fund. As a result of market fluctuations alone, your 20 stock fund shares are now valued at $5,000, and your 20 bond fund shares are worth $2,000. Your total portfolio balance—$7,000—is now split approximately 70/30 between stocks and bonds, making your portfolio overweight in stocks.

This scenario may be profitable right now—after all, you have more money invested in the higher-performing asset class. So what’s the danger? What goes up can come down. If you lose parity with your target asset mix by remaining more heavily invested in stocks and they go down in value, you have more to lose than you anticipated.

How to rebalance

If your current asset mix strays from your target by 5 percentage points or more, you may expose yourself to a level of risk (either too much or too little) that doesn’t align with your long-term goals. Rebalancing your portfolio realigns your current asset mix with your target mix.

Before you decide how to rebalance, think about timing. Do you want to return to your target asset mix immediately or are you comfortable doing so incrementally?

Return to your target ASAP

In the example above, you have too much in stocks and not enough in bonds. To correct the balance, you can direct more money into bonds by making a purchase into your bond fund from a linked bank account (or by check). You can also exchange money from your stock fund into your bond fund. Both of these options can immediately realign your current asset mix with your target.

Return to your target over time

Using the same example, you can restore balance in your portfolio by directing investment distributions (dividends and capital gains) from your stock fund into your bond fund. Because you can’t predict the exact amount of future fund distributions, this option may require patience and regular monitoring.

If you invest in a taxable (i.e., nonretirement) account and sell investments that have gained value, you’ll most likely owe taxes. To avoid this situation, you could create a target asset mix that incorporates all of the accounts in your portfolio. Then you can compare your overall asset mix to your target rather than looking at each account individually. If you rebalance only within tax-advantaged (i.e., retirement) accounts, you won’t owe taxes if you sell investments that have increased in value. Note: We recommend that you consult a tax or financial advisor about your individual situation.

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