Understanding Rebalancing in Investment Portfolios

Very Hard Investment Policy And Allocation Rebalancing

Consider an investment portfolio structured with a target asset allocation of 60% stocks and 40% bonds. Over a year, the portfolio's stocks appreciate significantly by 25%, while the bonds yield a modest 5% increase. At year's end, the total value of the portfolio is $1,000,000.

Given the rise in asset values, the new proportions of the assets will have changed, potentially necessitating a rebalancing of the portfolio to maintain the original asset allocation. Which of the following describes the most appropriate reason for rebalancing the portfolio to its original allocation?

To lock in profits from stocks and maintain the risk level consistent with the investor's risk profile.

To capitalize on the gains in bonds, as they are expected to outperform stocks in the near term.

To reduce transaction costs associated with trading as the portfolio grows larger.

Hint

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