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URL:  http://boards.fool.com/the-general-rule-for-a-diversified-portfolio-is-16820023.aspx

Subject:  Re: Handling stocks in an IRA Date:  2/28/2002  6:23 PM
Author:  Hyperborea Number:  33895 of 75540

The general rule for a diversified portfolio is to rebalance it regularly to maintain the target asset allocation percentages. Most people rebalance on a yearly basis.

The reason for rebalancing on a regular basis is that it forces you to sell some of the assets that have appreciated to buy more of the assets that have gone down in price. This has the important effect of 'Buying Low and Selling High' that many people only dream about.


Though here the momentum effect can also be the allocator's friend too. The studies that I've seen have suggested that rebalancing once a year, as you suggest, or even every other year can bring additional, though small, gains over more frequent rebalancing. The basis for this is that momentum will carry an asset class in the same direction for the following period it has been moving over the past period. The range of time that this momentum effect is valid seems to die out after about 2 years.

You can verify this yourself by computing the self-correlation of the movement of a particular index or asset class though I'm not sure if it applies to individual stocks. The self-correlation is correlation of the returns of an asset class at time t with the returns of the same asset class at time t+1 over all applicaple values of t.

Hyperborea
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