What is portfolio rebalancing?

What is Portfolio Rebalancing?

Portfolio rebalancing is the process of realigning the weightings of the assets in an investment portfolio. It involves buying or selling assets in a portfolio to maintain the original desired level of asset allocation, or to adjust it to reflect changes in financial goals, market conditions, or personal circumstances.

Why is Portfolio Rebalancing Important?

Over time, the values of different assets in a portfolio can change due to market conditions. Some investments may grow faster than others, causing the portfolio to become unbalanced. Portfolio rebalancing ensures that the portfolio continues to reflect your investment objectives, risk tolerance, and time horizon.

How Does Portfolio Rebalancing Work?

Let’s say your portfolio originally had 60% stocks and 40% bonds. Over time, the value of stocks may increase significantly, and now your portfolio may consist of 70% stocks and 30% bonds. In such a case, you might rebalance your portfolio by selling some of your stocks and buying more bonds to bring the asset allocation back to 60% stocks and 40% bonds.

When Should You Rebalance Your Portfolio?

Portfolio rebalancing is generally done on a regular schedule, such as annually, semi-annually, or quarterly. However, you can also rebalance when there is a significant shift in the market or when your personal financial situation changes. Here are a few reasons you may want to rebalance your portfolio:

• Market Movements: If one asset class outperforms others significantly, it might become overrepresented in your portfolio.
• Change in Financial Goals: If your goals change, such as nearing retirement or funding a major purchase, you may need to adjust your risk profile and asset allocation.
• Life Changes: Major life events, such as marriage, a new job, or having children, could mean you need to reassess your portfolio.

Steps for Portfolio Rebalancing

1. Review Your Asset Allocation: The first step in rebalancing is to check your current asset allocation. Compare your actual portfolio distribution with your target allocation.
2. Decide How Much to Buy or Sell: Once you know which assets need adjustment, decide how much to buy or sell to restore the balance.
3. Perform the Transaction: You can sell off the overrepresented assets and purchase more of the underrepresented assets. Ensure you understand any tax implications of these transactions.
4. Set a Rebalancing Schedule: It’s a good idea to rebalance your portfolio on a regular schedule to maintain the desired asset allocation over time.

Benefits of Portfolio Rebalancing

• Reduced Risk: By rebalancing, you maintain your desired risk level and avoid overexposure to any single asset class.
• Improved Returns: Rebalancing can help capture returns from underperforming assets by buying them at lower prices and selling overperforming assets at higher prices.
• Aligned with Financial Goals: Regular rebalancing ensures that your portfolio continues to reflect your changing financial goals and risk tolerance.

Conclusion

Portfolio rebalancing is an important process that helps investors maintain their desired risk level, capture returns, and stay aligned with their financial goals. By regularly reviewing and adjusting your asset allocation, you ensure that your portfolio remains in line with your long-term objectives. Whether you do it annually or after significant life changes, rebalancing is a key part of successful investing.