Everything to know about Portfolio Rebalancing
Risk management plays a significant role in effective portfolio creation regardless of your investment style or approach. Investors who take risk management seriously and take a proactive attitude to realign their portfolios are more likely to prevent major blunders when the bull market starts catering.
Rebalancing portfolios is rarely done by people — but is extremely essential to your investment approach.
What is Portfolio Rebalancing
Portfolio Rebalancing is the method of modifying your asset allocation as the amount of money in each investment fluctuates with the ever-changing economy. Everything boils down to one thing: asset allocation. That is, how much money you are investing in your portfolio in certain "asset classes."
In other words, portfolio rebalancing is the weighting method of an asset portfolio. Rebalancing includes purchasing or selling assets in a portfolio regularly to preserve an initial or desired amount of asset allocation or risk.
For instance, say 50 percent stocks and 50 percent bonds were an initial target asset allocation. If shares performed well over the period, the stock weighting could have risen to 70% of the portfolio. Then the investor may decide to sell some stocks and purchase bonds to return the portfolio to the initial 50/50 target allocation.
When to rebalance your portfolio
With a diverse combination of different kinds of investment, your investment strategy is likely to be designed for the long term. But there are times when you need to consider rebalancing the portfolio.
It may be time to review your portfolio and consider rebalancing your investment mix if for example:
- Changes in your tolerance to risk.
- A financial goal must be achieved, such as assisting a kid pay for college.
- You're near retirement
You can rebalance your portfolio to restore the asset allocation you want when your investment goals, time horizon, and risk tolerance change. Just remember that using asset allocation does not ensure yields or defend you against future losses.
How portfolio rebalancing works
Say the stock market benefits have swelled your portfolio's stock part over the previous three years. You can return to your initial allocation if the present level is too big for your risk tolerance.
How are you going to do that?
- You can transfer cash from stocks to other asset classes, such as bond and money market funds.
- Or you can invest more in asset classes that are underrepresented until you reach the total allocations you want.
Try Automatic Rebalancing
Rebalancing can be regular and automatic depending on the type of investment. Funds such as asset allocation funds divide their equity wealth between stocks, bonds, and money. Rebalancing becomes automatic to remain within the goals and risk parameters of the portfolio.
If you think asset allocation is essential to your actual returns, you are also expected to rebalance your portfolio to attain the required vision. Although at first portfolio distribution may seem complex, the approach is comparatively simple as you already understand the thresholds that need to reach your portfolio. This should make it much easier to select assets.