Understanding Asset Allocation and Rebalancing
What is Asset Allocation in Simple Terms
Asset allocation is how you divide your investment portfolio among different asset classes, such as stocks, bonds, and cash. For example, you might aim for 60% stocks, 30% bonds, and 10% cash. Asset allocation is a key factor in determining your portfolio's risk and return potential. Stocks generally offer higher potential returns but more volatility, while bonds typically offer lower returns but more stability. Cash provides liquidity but minimal growth.
Why Investors Rebalance Portfolios
Over time, market movements can cause your actual allocation to drift away from your target. For example, if stocks perform well, your stock allocation might grow from 60% to 70%, making your portfolio riskier than intended. Rebalancing means adjusting your portfolio back toward your target allocation by selling overweight assets and buying underweight assets (or directing new contributions to underweight areas). This helps maintain your desired risk level and can potentially improve returns by "selling high and buying low" in a disciplined way.
How This Tool's Rebalancing Logic Works at a High Level
This tool compares your current portfolio allocation (by asset class) with your target allocation. If any asset class is off by more than your drift threshold, it suggests rebalancing moves. In "contribution-only" mode, it directs new money to underweight classes. In "trades-allowed" mode, it can suggest selling from overweight classes and buying into underweight classes. The tool applies constraints like minimum trade size and rounding to make suggestions more practical. It's a simplified algorithm that doesn't account for taxes, fees, or complex portfolio management strategies.
What This Tool Does NOT Cover (Taxes, Trading Costs, Real Account Rules)
This calculator is a simplified educational tool and does not account for many real-world factors: Taxes: Rebalancing in taxable accounts can trigger capital gains taxes, which this tool does not model. Trading costs: Brokerage fees, bid-ask spreads, and other transaction costs are not included. Account rules: Specific account types (401(k), IRA, taxable) have different rules, contribution limits, and tax treatments that this tool doesn't consider. Market timing: The tool doesn't consider whether it's a good time to trade based on market conditions. Complex strategies: Tax-loss harvesting, asset location optimization, and other advanced strategies are not modeled. Always consider these factors when making actual rebalancing decisions.
Note: This calculator is for educational purposes only and does not provide personalized financial, tax, or investment advice. It does not recommend specific investments, strategies, or actions. Always consult with qualified financial advisors, tax professionals, and your own research before making investment decisions.
Frequently Asked Questions
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