For investors
21 Mar 2024

Achieving Investment Excellence: The Importance of Portfolio Rebalancing

Portfolio rebalancing is a highly regarded tactic used by many renowned investors and is closely related to the buy-and-hold strategy. Building a portfolio and forgetting about it until retirement isn't the optimal approach to investing. It requires regular check-ins and adjustments to ensure that financial goals stay on track. A critical aspect of this maintenance is portfolio rebalancing, a practice that is often overlooked but essential for long-term success.

Achieving Investment Excellence: The Importance of Portfolio Rebalancing

What Is Portfolio Rebalancing?

Portfolio rebalancing is the process of realigning your investments to maintain your desired level of risk and return. As your investments fluctuate in value, your portfolio's asset allocation may change from your original plan. For example, if you planned to hold 80% stocks and 20% bonds, but market movements change this to 85% stocks and 15% bonds, rebalancing involves selling some stocks and buying more bonds to return to the original allocation.

The Importance of Rebalancing

Why is it necessary? First, rebalancing keeps your portfolio's risk in check. Without it, your allocation could shift toward riskier assets over time, potentially derailing your financial goals. Second, rebalancing can enhance returns, especially when it adjusts asset classes with similar long-term expected returns.

Strategies for Rebalancing

In addition to understanding the importance of portfolio rebalancing, it's important to explore different strategies for doing it effectively:

Percentage Range Rebalancing: This involves setting a tolerance level, such as 5%, for deviations of asset classes from their target weights. The tolerance can vary depending on the investor's risk tolerance and commitment to maintaining the portfolio's allocation.

Time-Based Rebalancing: Investors can choose to rebalance on a predetermined schedule, such as annually, quarterly, or semi-annually. While there's no one-size-fits-all approach, less frequent rebalancing can lead to higher equity allocations and returns, albeit with increased volatility.

Allocating New Funds: Adding fresh capital to underweighted asset classes helps rebalance the portfolio to its original allocation.

Withdrawal Adjustments: When funds are withdrawn, selling some of the overweight assets can help reduce their weight in the portfolio and ensure adherence to the desired allocation.

Using Robo-Advisors for Rebalancing

For those seeking a hands-off approach, robo-advisors offer a convenient solution. These automated platforms construct and manage diversified portfolios based on your financial goals and risk tolerance. Robo-advisors offer investors access to well-diversified investment portfolios, rebalancing, and other features, such as tax-loss harvesting, with low or no management fees.

Considering Costs and Benefits

Portfolio rebalancing carries costs, including trading fees and potential taxes on capital gains. That's why it's important to evaluate the cost-benefit ratio before proceeding. If the costs outweigh the benefits, it may make sense to rebalance only some positions or even skip rebalancing altogether.

The Bottom Line

At its core, rebalancing is a proactive strategy for maintaining financial stability and optimizing returns. By regularly rebalancing your portfolio, you can mitigate risk, take advantage of opportunities, and stay on track toward your investment goals. Whether you prefer a hands-on or automated approach, finding the right rebalancing strategy will ensure your financial fitness for the long term.