Sophisticated portfolio rebalancing can improve your long-term results. Historic data indicate that:
* Long-term, bonds beat inflation by around 3 percent a year.
* Long-term, stocks beat inflation by around 6-7 percent a year. That’s true even after last year’s stock market crash–if you have a truly long-term perspective. The catch, of course, is that stocks are much more volatile than bonds. A bad year for stocks is much worse than a bad year for bonds.
How can you find the right mix of superior returns (stocks) and stability (bonds)? One strategy is to sell stocks but not bonds.
Suppose, for example, you want a 50-50 mix of stocks and bonds. In a "typical" year, stocks will go up more than bonds. You can sell stocks and buy bonds, bringing you back to a 50-50 allocation.
Some years, though, stocks will lag bonds: stocks will have smaller gains or larger losses. In those years, hold onto your allocation. Eventually, your stocks will gain enough to catch up and pass your bonds, when you can start selling stocks again. This strategy will keep your portfolio balance at 50-50, reducing your exposure to a crash after stock market booms.
