Young poker players and their winnings?

[jively]

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15% US Total Stock Market Index
15% US Large Cap Value Index
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So let say I have 100k to invest every year. Do I keep putting 15k in US Total Stock Market Index, 15k in US Large Cap Value Index etc. every year for the next 20 years? The reason I am asking this because I do not get the idea of asset allocation.

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No, not exactly. The best thing to do is to determine the exact allocation that you want, and then to keep that allocation for many years. Any time you add or remove money from a portfolio, or every year or so if there are no cash flows, you want to do a portfolio rebalance. That means that when you are done, you want the proportions of the funds to be exactly right.

Let's say you put in $100K the first year, and after a year, the portfolio has grown to $110K, a gain of 10%. You are adding $100K for the second year. When you are done, you'll have $210K in your portfolio. So, you'll want 15% of $210K, or $31,500 in US Total Stock Market Index, $31,500 in US Large Cap Value Index, and so on.

Each of the funds had a different performance in the first year. You started with $15,000 in US Total Stock Market Index, and let's say that fund went up only 4% to $15,600. You need to add $31,500 - $15,600 or $15,900 to this fund this year. You started with $15,000 in US Large Cap Value Index, and let's say that fund went up 12% to $16,800. You need to add $31,500 - $16,800 or $14,700 to this fund this year.

So, you add more money to the funds that have gone up the least (or went down), and you add less money to the funds that have gone up the most.

In retirement, it's done exactly the same in reverse. You'd sell the funds that have gone up the most.

If you are rebalancing without adding money or removing money, you do the same thing, and exchange from the funds that have gone up most (the overweight ones) to the ones that have gone up less or gone down (the underweight ones).

After you finish this type of rebalance, your portfolio is back to the original weightings, so it is balanced and diversified. It is excellent in that is unemotional, and causes you to buy low and sell high. Most people don't have the discipline to do this; they tend to sell their losing funds and buy more of the winning funds, which tends to increase their risk and usually give them a pretty bad year at some point soon.

-Tom