Building a successful investment portfolio is about more than just picking the right assets––you also need to periodically reassess and adjust your allocations to maintain your desired balance between risk and return. This process, known as rebalancing, is key to ensuring that your portfolio remains aligned with your financial goals and risk tolerance.
In this guide, we’ll explore when to rebalance your portfolio and how to effectively do it so that you can keep your investments on track for long-term growth.
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Understanding Portfolio Rebalancing
Portfolio rebalancing is the act of realigning your portfolio’s asset weightings. Occasionally, you may need to buy or sell assets to maintain your original or desired level of asset allocation or risk.
Over time, some investments will grow faster than others, causing your portfolio to drift away from its target allocation. Portfolio rebalancing brings it back to your original asset mix, helping you manage risk and potentially improve returns.
Portfolio Rebalancing Strategies
So when do you know it’s time to rebalance? It depends on your approach. There are a few strategies you can use to rebalance your portfolio.
Time-Based Rebalancing
With this strategy, investors adjust their asset allocation at regular, predetermined intervals, such as quarterly, semi-annually, or annually. The primary goal is to maintain the original or desired allocation of assets despite fluctuations in market values.
Before adopting this approach, consider these key factors:
- Transaction Costs: Frequent portfolio rebalancing can incur trading fees, which may erode returns, especially in smaller portfolios.
- Tax Implications: Selling assets to rebalance your portfolio may trigger capital gains taxes in taxable accounts, reducing net return.
- Market Conditions: Fixed-time rebalancing doesn’t account for market conditions, which may lead to rebalancing at inopportune times.
- Risk Tolerance: Consider your personal risk tolerance when pursuing time-based rebalancing. Make sure the rebalancing frequency aligns with your investment horizon.
Because time-based rebalancing doesn’t consider these factors as a given, it’s important to stop and think about your personal goals and what you’re ultimately hoping to achieve with portfolio rebalancing.
Constant Proportion Portfolio Insurance
Constant Proportion Portfolio Insurance is a dynamic strategy that leverages both aggressive and conservative investing elements. It involves greater allocation to risk assets when markets are performing well and allocating towards safer assets like bonds when markets are declining.
This approach consists of two key components: the floor and the multiplier. The floor is the minimum value you want the portfolio to maintain in order to meet your investing goals. The multiplier is the remaining amount above the floor.
For example, if you have a portfolio that’s worth $100,000, a $60,000 floor, and a multiplier of 2, you would perform the following calculation to determine your allocation at inception:
2 x ($100,000-$60,000) = $80,000
Say your portfolio drops to $80,000. In that event, you would rebalance using the same formula:
2 x ($80,000-$60,000) = $40,000
This approach can help you capitalize on bull markets and weather the downturns of bear markets.
Percentage-of-Portfolio Rebalancing
Percentage-of-portfolio rebalancing involves adjusting your portfolio whenever an asset class deviates from its target allocation by a predetermined percentage. For example, if a portfolio’s target is 60% stocks and 40% bonds, the investor might rebalance whenever stocks move 5% above or below this target.
This approach helps maintain your desired risk profile by realigning the portfolio back to its intended allocation. It is more responsive to market fluctuations than time-based rebalancing, as adjustments occur based on the actual performance of the assets rather than on a fixed schedule.
How to Rebalance Your Portfolio
Once you’ve determined the approach you want to follow, there are a few steps you should take to start portfolio rebalancing successfully:
- Assess Your Current Portfolio: Review your current asset allocation to determine how far it has drifted from your target allocation.
- Identify Needed Adjustments: Calculate the amount of each asset class you need to buy or sell to bring your portfolio back to its target allocation.
- Consider Transaction Costs: Consider the fees associated with buying and selling assets. High transaction costs can erode the benefits of rebalancing, so it’s important to minimize them.
- Rebalance: Execute the necessary trades to adjust your portfolio. This may involve selling a portion of over-weighted assets and buying more of the under-weighted ones.
- Review and Repeat: Continually monitor your portfolio and establish a routine for assessing and rebalancing as needed.
Many investors opt for automated rebalancing tools offered by robo-advisors and brokerage platforms. These tools automatically adjust your portfolio based on predefined parameters, saving you time and effort. They can also help ensure that rebalancing occurs consistently and without emotional bias.
Rebalance Your Portfolio Start Mitigating Risk Today
Portfolio rebalancing offers numerous benefits, including risk management and the potential for bigger returns, so it’s in your best interest to rebalance as often as needed. By following these tips, you can determine when and how to rebalance your portfolio and get on track to greater financial success, both now and in the long term.
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