Have you heard the term “paper loss?” It’s a nice way of saying that you haven’t really lost money on your investment until you place a sell order. Most investors become familiar with this phenomenon occasionally in their investing life. But what about the seldom used term “paper gain?” It’s very likely that you have never heard of that one (since I want to believe I coined it!). It is the opposite of a loss situation. You actually made money! But guess what? It’s only on paper until you sell.
Enter the act of rebalancing your portfolio. Rebalancing simply means getting your portfolio back in line with the percentages you originally wanted based on your risk tolerance. Consider this example:
Your ideal mix consists of:
- 60% stocks
- 30% bonds
- 10% cash
In six months your portfolio now has percentages like this:
- 70% stocks
- 20% bonds
- 10% cash
The market went up and generally the value of your portfolio will go up so you’re happy, aren’t you? But your portfolio is now riskier and you will need to get it back to your original mix. That means selling 10% of stocks and buying 10% of bonds.
Look what just happened, you sold an investment (stocks) that went up and you bought an investment (bonds) that was priced lower. You are now back to your 60-30-10 mix. Ever hear that term “buy low, sell high?” Thank you rebalancing.
Oh and another thing, check to see if your retirement plan at work offers auto rebalancing. Great thing to put on auto pilot!