When it comes to investing, maintaining a balanced portfolio is a crucial aspect of long-term success. A key strategy in achieving this is rebalancing your portfolio. In this blog we will explore what portfolio rebalancing means, why it is so important, and when you should consider rebalancing your investments.
What Does it Mean to Rebalance Your Portfolio?
Portfolio rebalancing is the process of evaluating and redistributing your investments within a portfolio to ensure that the allocation matches the original plan’s weightings. This is typically done to preserve risk-tolerance, re-align with goals, and optimize returns. When you rebalance your portfolio, it will involve the buying and selling of mutual funds, exchange-traded funds, and other investments, based on the existing contents of your portfolio to bring your investments back in line.
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Why Rebalance Your Portfolio
One of the primary goals in rebalancing your portfolio is to avoid overexposure to risk. As the market fluctuates, your portfolio can drift away from your original asset allocation, potentially leaving you open to increased risks. By rebalancing, your risk that was increased through reliance on any single investment, can be reduced, leaving you with a better diversified portfolio.
Rebalancing is not only a risk reduction strategy; it can also enable you to capitalize of new market opportunities. As some asset classes experience significant growth, others lag behind, providing you with an opportunity to sell the outperforming assets and invest in those with a potential for future growth. These fluctuations in the market can lead to emotional decision-making, which rebalancing can minimize by following the predetermined strategy.
When You Should Rebalance Your Portfolio
Typically rebalancing your portfolio happens in three scenarios.
Interval Rebalancing
This approach involves reviewing and adjusting your portfolio at set time intervals, such as quarterly, semi-annually, or annually. This approach provides a consistent output and ensures your portfolio stays on track.
Threshold-Based Rebalancing
In this scenario you will monitor your portfolio’s asset allocation and rebalance it when deviations from your targets exceed specific predetermined thresholds. This is a more flexible method and avoids unnecessary trades when fluctuations are within reasonable ranges.
Event-Driven Rebalancing
This last approach is based on your own personal circumstances. Significant life events, such as marriage, the birth of a child, or retirement, can affect your financial goals and adjust your risk tolerance. Taking the time to re-asses and re-align your investments during these times will help to ensure your portfolio yields the best possible results for you in the long-term.
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