It’s not just important to diversify into different kinds of investments, it’s also essential to have the right mix of investments given your current risk tolerance. And your risk tolerance will change over time as you get older and closer to retirement.
That means you need to change what you’re invested in over time, which likely means moving some of your money from stocks to bonds. If you invest in a target-date fund, this shift will happen automatically. But if you don’t, you’ll need to manually make adjustments.
Unless you’re invested in a target-date fund, you might also need to make changes to your investments over time if some of them perform better than others. Take a simple example. Say you have $1,000 and want 80% of your portfolio invested in stocks, so you spend $800 on an index fund that tracks the stock market and $200 on a fund that gives you exposure to bonds.
Now say your stocks perform well over time and grow more than your bonds so you end up with $1,500 in stocks and $300 in bonds. You now have 83% of your portfolio in stocks so you might want to sell some and buy more bonds to get back to your desired 80% split. In this case, you’d need to rebalance your portfolio to correct your asset allocation.