Last Updated Apr 8, 2011 3:53 PM EDT
Rebalancing the Nasdaq 100 means reducing the proportion of the index that Apple (AAPL), one of the strongest stocks in recent years, accounts for. In the way the term is more commonly used, rebalancing involves periodically restoring the holdings in a portfolio to some set of desired weightings based on factors such as personal financial circumstances, age and tolerance for risk.
If there is a standard balance that financial planners recommend, it's 60 percent in stocks and the rest in bonds, but 70/30 is also mentioned frequently. Sometimes a cash component is added, usually at the expense of bonds; a three-asset portfolio that's often suggested contains 60 percent stocks, 30 percent bonds and 10 percent cash.
Because investors are encouraged to become more conservative as they get older, some planners advise holding bonds in a percentage equal to an investor's age, with the rest being allocated to the stock market. Someone who is 25 and just starting out as an investor, and therefore has plenty of time to recoup losses after a bad run, would have 75 percent of his portfolio in stocks, while a 60-year-old on the verge of retirement would reduce his risk by keeping 60 percent in bonds, which are generally less volatile than stocks.
Whatever allocation you prefer, planners urge you to rebalance to bring it back into line in one of two ways: periodically, say once or twice a year, or when your portfolio gets out of whack by a certain amount, say 5 or 10 percentage points. If your benchmark is 60 percent stocks/40 percent bonds, you might wait until the mix goes to 50/50 or 70/30 and then sell enough of the asset class that has outperformed - if you've got shares of Apple that have soared over the years, it would be an obvious candidate - and buy more of the weaker one to bring the portfolio back to your desired weightings.
By settling on an allocation that is appropriate for you, developing a strategy for rebalancing and then having the discipline to stick with it, financial planners say, you should be able to achieve stronger returns, lower risk and maybe both over the long haul. There's nothing magical or mysterious about the process, they say. It works because it forces investors to observe a very useful yet often elusive piece of conventional wisdom: Buy low, sell high.