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Continuing Process

It certainly takes some effort to optimally reorganize your investment portfolio to be as tax-efficient as possible. Once this is completed, so is most of the work. However, the stock and bond markets move in cycles. While it may not be possible to predict these cycles in advance, we do see how they affect our asset allocation afterward. When the stock market has a particularly good year, you will notice that your portfolio has moved away from the optimal asset allocation. If you put 20% of your investment in stocks, you may find that the good performance of the stock market has led you to have an allocation of 25% stocks. In other words, you will find that over time your actual asset allocation drifts away from your desired allocation.

Rebalancing is the process of getting your portfolio allocation back to its desired allocation levels. For people still accumulating wealth for retirement, my recommendation is to get back into the desired allocation through the targeting of your investment contributions. That is, if your portfolio has become too weighted toward stocks and away from bonds, then change your 401(k) plan contributions to go to bonds. By directing your contributions to the asset classes that are underweighted, you can get back to your optimal allocation. This is a good strategy because it inherently causes you to buy low. You buy the asset class that recently has underperformed. That underperformance leads to underweighting in the allocation and in your new contributions.


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