The art of portfolio rebalancing is a crucial practice for maintaining long-term growth. Similar to an experienced gardener caring for their flowers, portfolio rebalancing involves making regular changes to asset allocations. This practice ensures that your investment strategy stays in line with your financial objectives and tolerance for risk.
What is portfolio rebalancing?
Portfolio rebalancing is a strategic process that involves buying or selling assets within an investment portfolio to maintain its desired asset allocation. This practice aims to restore balance among asset classes, ensuring that your portfolio remains aligned with your long-term investment objectives.
Why is portfolio rebalancing important?
Portfolio rebalancing serves several critical purposes such as:
Maintaining Risk Discipline:
By adhering to your target asset allocation, rebalancing prevents your portfolio from straying too far from your risk tolerance. This helps to mitigate the impact of market fluctuations and protects your overall investment strategy.
Rebalancing ensures that your portfolio remains diversified, preventing any single asset class from dominating your investments. This diversification helps to reduce overall portfolio risk and enhance potential returns.
Capitalizing on Market Fluctuations:
Rebalancing provides an opportunity to sell assets that have outperformed and purchase those that have underperformed. This strategy allows you to capture gains from winning investments while replenishing underperforming ones, promoting long-term growth.
Steps to rebalance your portfolio
Step 1: Determine your target asset allocation
Your target asset allocation represents the ideal mix of asset classes for your portfolio. It should reflect your risk tolerance, investment horizon, and financial goals.
Step 2: Calculate your current asset allocation
Determine the current percentage of your portfolio allocated to each asset class. This will help you identify any discrepancies from your target allocation.
Step 3: Rebalance your portfolio
To bring your portfolio back to your target allocation, you may need to sell some of your outperforming assets and reinvest the proceeds in underperforming ones.
Addressing Asset Class Performance Disparities
If an asset class has significantly outperformed your expectations, rebalancing may involve selling a portion of those assets to bring them back in line with your target allocation. This helps to control risk and prevent overexposure to any single asset class.
Conversely, if an asset class has underperformed, rebalancing may involve purchasing more of those assets to bring their allocation closer to your target. This strategy allows you to take advantage of their potential for future growth while maintaining diversification.
How often should you rebalance your portfolio?
The frequency of rebalancing depends on your circumstances and investment strategy. Some investors rebalance annually, while others may choose to rebalance more frequently, such as quarterly or even monthly.
As a general rule of thumb, rebalancing is recommended when your asset allocations deviate significantly from your target allocation. This could be due to market fluctuations, new investments, or changes in your financial goals or risk tolerance.
Common rebalancing strategies
- Calendar Rebalancing: Rebalancing on a fixed schedule, such as annually or semi-annually.
- Percentage-of-Portfolio Rebalancing: Rebalancing when an asset class’s allocation deviates from its target by a predetermined percentage.
- Constant-Proportion Portfolio Insurance: Rebalancing to maintain a constant proportion of risky assets to risk-free assets.
Examples of portfolio rebalancing
Example 1: An investor with a target asset allocation of 60% stocks and 40% bonds may rebalance if their portfolio’s stock allocation has grown to 70% due to market performance.
Example 2: An investor nearing retirement may rebalance their portfolio to reduce their exposure to risky assets and increase their allocation to more conservative investments, such as bonds.
Effective Tips to Keep Your Investments Aligned
- Create a rebalancing plan
Outline a rebalancing schedule and establish clear thresholds for rebalancing actions.
- Consider tax implications
Be mindful of potential capital gains taxes when selling assets during rebalancing.
- Seek professional advice
Consult a financial advisor for personalized guidance and recommendations.
EQBAC is a trade execution platform that can help you and your financial advisor create
and manage your portfolio, including rebalancing. With EQBAC, you can:
- Create a personalized target asset allocation based on your risk tolerance and investment goals.
- Track your portfolio’s performance and identify asset allocation discrepancies.
- Receive automated rebalancing alerts when your portfolio deviates from your target allocation.
By maintaining your target asset allocation and capitalizing on market fluctuations, rebalancing helps you stay on track with your financial goals while minimizing unwanted risks. Click here to know more.