Portfolio Rebalancing: When and How it Should be Done

For investors who prefer to follow the investment strategy of keeping particular asset allocation balances in a portfolio, rebalancing will certainly take place.

Rebalancing means returning the weightings of a portfolio of assets. It involves selling and/or buying assets in a portfolio to realign the desired level of asset allocation.

If an investor wants 10 percent cash, 20 percent bonds, and 70 percent stocks, but the stocks performed well during the period that it raised its weighting up to 95 percent, the investor may then choose to sell stocks to bolster the cash and bonds.

If the investor’s investment plan or goal remains unchanged, the portfolio’s mix should not either. However, due to market forces, the mix tends to change.

Learn more: Investment Portfolio: Asset Allocation and Risk Tolerance

When should a portfolio be rebalanced?

Typically there are two things to consider when determining the right time for investment portfolio rebalancing.

1. When the weightings of the asset allocation are not in line with the targets or parameters the investor created.

2. When the asset allocation weightings are not in proportion to the targets or parameters at a set time or times per year.

How to do it?

Even though no certain investment method can fully guarantee success, these rebalancing strategies can be effective.

Calendar Rebalancing

This is the simplest rebalancing approach. It basically involves assessing investments in a given time and making adjustments to the original allocation at a desired rate.

Monthly and quarterly valuations are usually the ideal rebalancing period. Weekly approach can be very costly, while doing it every year could result to excessive intermediate portfolio drift.

Time limits, transaction costs, as well as allowable drift are some of the factors to consider when determining the right frequency of rebalancing.

Percentage Rebalancing

This strategy would require more monitoring than the time-based method. Percentage-based rebalancing is carried out when an asset allocation changes by a specific percentage that the investor had previously selected.

For example, if the threshold of change chosen was at 5 percent and the target allocation of stocks was 50 percent of the portfolio, the portfolio would have to be rebalance if the stocks went up to 55 percent.

This approach however, can get more expensive than calendar rebalancing during volatile markets. Investors could be buying and selling more often and possibly acquiring trading costs, which will vary based on the structure of the portfolio.

See also: Volatility Trading: What is it?

Conclusion

Rebalancing can offer security and discipline for any investment approach. It is a personal choice that investors need to make after carefully weighing the options. Thinking about what may happen to the portfolio in all market conditions can help motivate investors to rebalance when needed.

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