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Portfolio Rebalancing

Every once in a while, your portfolio might need to ‘rebalanced’ so that it still follows the investment strategy you set or so that it follows your new investment strategy.

What Does It Mean to Rebalance Investments?

When an investor rebalances their portfolio, they adjust the weight of each individual investment or asset class to account for risk tolerance. As the market changes over time, investors may find that their portfolio no longer has the right balance.

For example, if a portfolio has an asset allocation of 60% stocks and 40% bonds, then keeping that balance may be necessary for an investor to fund future financial goals. As the market changes, the investments could become more valuable and the weight inside the portfolio could change to, let's say, 70% stocks and 30% bonds. Rebalancing would reallocate the money earned in stocks into bonds to maintain that original asset allocation.

Portfolio Rebalancing

Portfolio rebalancing involves adjusting one's portfolio to match the original asset allocation plan.

Assets that perform well this year aren’t guaranteed to perform well next year and, if they don’t, then the portfolio’s overall growth could decline. Rebalancing can help investors take advantage of the opportunity to buy low and sell high, increasing their overall profits.

Importance of Rebalancing

The importance of portfolio rebalancing will vary depending on an individual investor’s tastes and financial goals. Some of the benefits and reasons to regularly rebalance a portfolio include:

  • The risk of the portfolio remains the same.
  • Rebalancing improves the diversification of a portfolio.
  • Investing remains disciplined and emotions play less of a role in asset decisions. This can lead to better long-term returns.
  • An investor can have better peace of mind, knowing they are on target for financial or retirement goals.
How Often Do You Need to Rebalance Your Portfolio?

You can rebalance your portfolio periodically or when the asset mix changes by a certain amount. Ideally, you want to avoid panic trades from over-checking and also be able to monitor your portfolio.

Periodic rebalancing allows you regularly monitor and control the risk in your portfolio. A con of rebalancing periodically is that you might end up overdoing it. Even if you schedule rebalancing on a certain date, you don’t necessarily have to change the asset mix if the portfolio still suits you.

The other method is to rebalance when the asset allocation shifts. When the asset mix of your portfolio changes, its risk-to-return ratio may no longer suit you. So, investors might prefer to rebalance their portfolios when the asset mix changes too much.

A common rule of thumb used by investors is to rebalance when the asset allocation for any subset shifts by 5%. If you followed this rule and the portion of stocks increases by 5%, you would rebalance.

Different Types of Portfolio Rebalancing Strategies

Calendar Rebalancing

Periodic rebalancing involves committing to rebalancing your portfolio with a fixed interval. Periodic rebalancing allows you to monitor your portfolio regularly. However, some investors may fall into the trap of overdoing rebalancing when not needed. You need not rebalance if your portfolio still suits you.

Threshold-Based Rebalancing

When you set your rebalancing according to the changes is asset allocation, it is called threshold-based rebalancing. As we have discussed earlier, the goal is to maintain a certain asset mix. If your desired assets mix changes, you may decide to rebalance accordingly.

Risk Parity Rebalancing

You may decide to rebalance your portfolio when the overall risk of the portfolio increases. You may also decide to rebalance when the asset allocation to risky assets go beyond a certain point. This form of rebalancing is called risk parity rebalancing.

Do tax considerations when rebalancing

If you need to sell assets to rebalance your portfolio, take time to consider any tax implications.

Instead of selling, investors may also stop making new contributions to certain asset classes and redirect those funds to underweighted holdings as a way to rebalance over time. This strategy minimizes potential tax liabilities.

When rebalancing, it’s important to pay attention to the type of account your assets are in and the length of time you’ve owned them. These factors will determine how your capital gains or losses are taxed.

Before making any changes, you may want to consult with a tax professional.

If you have questions about Portfolio Rebalance, consider reaching out us

Disclaimer

The contents herein mentioned are solely for informational and educational purpose only

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