In my last article, I introduced three exchange-traded fund portfolios for young investors to use within a taxable brokerage account. Because asset allocation is the most significant decision an investor makes, the portfolios were constructed to take advantage of the simplicity and cheapness of ETFs with the time horizon and needs of a young investor in mind. The next actionable step, and one that few young investors take, is to pick a rebalancing strategy. We'll explore the importance of rebalancing and the different methods that make the most sense for a young investor using the ETF portfolios. Rebalancing can help instill a disciplined mindset, which is especially important and useful for new investors.
The primary function of rebalancing is to control risk. The varying performance of asset classes over time causes a portfolio to shift away from its target asset allocation. For example, riskier assets exhibit more volatility, but also tend to outperform safer investments. Over time, as their proportional share grows, the risk of the portfolio drifts away from the target. Rebalancing controls this risk by moving capital between investments to re-establish the target asset allocation.
Abby Woodham does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.