Don’t forget to rebalance

Asset allocation is a concept underappreciated by investors — and not paying attention to it can be costly. Your asset allocation is how you’ve chosen to distribute your money across various asset classes, such as cash, stocks and bonds.

Once you determine the best allocation for your needs and risk tolerance, you’re not done. You’ll likely want to change it over time — for example, taking on less risk as you approach retirement — an adjustment known as “rebalancing.” (Target-date retirement mutual funds aim to do this for you, by the way.)

Imagine that you set up your portfolio to be 70% in stocks, 20% in bonds and 10% in cash. Stocks tend to grow more quickly than bonds, so in a few years, your portfolio’s mix might actually be 85% stocks, 10% bonds and 5% in cash. If that’s not the best allocation for you, you’ll need to rebalance it — by selling some stocks and buying more bonds — to get back to your ideal allocation mix.

Rebalancing can be especially easy if you’re mainly invested in lowfee index funds — such as ones that track the overall stock market and overall bond market. As examples, the SPDR S&P 500 ETF (SPY) will instantly have you invested in the S&P 500 universe of stocks, and the ishares Core U.S. Aggregate Bond ETF (AGG) will have you in a broad range of bonds. You’ll simply sell and buy the number of shares you need to.

If you’ve invested in individual stocks, you might identify your least promising ones and sell some or all of those. Be careful not to end up overweighted in your best performers, though. If one surging stock comes to represent 40% of your portfolio, for example, consider trimming that position to a more modest level. You don’t want too many of your eggs in one basket, even if it’s a promising basket.

You can learn more about asset allocation and rebalancing at Fool.com and by searching for those terms online.