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Navigating the world of investments requires a strategic and dynamic approach, and one crucial aspect often overlooked is portfolio rebalancing. In this exploration of mastering portfolio rebalancing, we delve into the reasons behind this essential practice and the meticulous steps involved in optimising your investments. Understanding why and how to rebalance your portfolio is key to maintaining a well-aligned and risk-conscious investment strategy, ensuring that your financial goals stay on course in the ever-evolving landscape of the market.
Table of Contents
Defining Portfolio Rebalancing
Portfolio rebalancing is a way to adjust your holdings to suit the evolving markets and your requirements. It means an investor changes the asset allocation of their portfolio to return to their desired portfolio make-up.
- As time progresses, varying assets yield different returns or losses, leading to shifts in the composition of a portfolio. For instance, a single stock or fund with substantial returns might eventually outgrow the desired allocation within an investor’s portfolio.
- Portfolio rebalancing also means getting rid of the underperforming assets and investing in new ones with better growth potential while maintaining the right asset mix.
- Also, it helps evaluate investments in case of revised investment goals.
- It also considers strategies like securities lending and borrowing (SLB), which can be employed to optimise returns by temporarily lending out certain securities in the portfolio for a fee or borrowing securities to hedge against potential market
fluctuations.
Need for Portfolio Rebalancing
In maintaining a resilient investment strategy, the need for portfolio rebalancing arises as market fluctuations can alter the initial asset allocation, requiring strategic adjustments to align with one’s financial goals and risk tolerance. Here is why it is needed.
Active Risk Management
With the fluctuation in the market, the level of risk that your portfolio is exposed to also changes. A rising market may call for large investments in the equity market but when suddenly the market drops, you will be exposed to a greater risk of loss. A proper rebalancing strategy will help you in balancing your risks in such instances.
Aligning Portfolio and Vision of Investment
With growing age and time, your risk tolerance level, investment capacity and goals are bound to change which requires you to re-plan your asset allocation and rebalance your portfolio. The asset allocation which you included in your portfolio a few years back may no longer work for you now.
Method to Rebalance Portfolio
An investor can do portfolio rebalancing themselves. Yes, it is as simple as that!
- Self-Management: Investors can take control of portfolio rebalancing by selling certain assets and acquiring others, a straightforward process that forms the crux of portfolio realignment.
- Assess Current Portfolio: The initial step involves a comprehensive review of the entire portfolio, analysing allocations across various sectors like stocks, international stocks, bonds, and exchange-traded funds (ETFs).
- Determine Ideal Asset Allocation: Knowledge of one’s ‘ideal asset allocation’ is paramount. Investors should refer to their initial investment goals or past allocation targets to establish a benchmark for their portfolio composition.
- Regular Monitoring: To effectively rebalance, investors must routinely track their quarterly and monthly statements, maintaining a clear overview of their overall allocation and invested capital.
- Application of Rebalancing Strategies: Armed with a thorough understanding of current investments, investors can strategically apply rebalancing methods that align with their financial objectives and risk tolerance, ensuring their portfolio remains in harmony with their vision of investment success.
Rebalancing Strategies
Disciplined Rebalancing
Annually, whether on your portfolio anniversary or a predetermined date, collaborate with your financial planner to meticulously reassess your asset allocation. Evaluate any substantial alterations in your risk tolerance that might impact your target asset allocation. Simultaneously, revisit your financial objectives, gauging your advancements toward achieving them during this strategic review.
Life-Stage Based Rebalancing
Tailoring your portfolio to life stages is crucial for financial alignment. Moving from single to married may increase the need for a larger emergency fund, approaching retirement requires a shift to lower-risk assets, and post-retirement calls for converting assets to stable, income-generating investments. These adjustments ensure a well-balanced and resilient investment strategy.
Trigger Based Rebalancing
Besides the regular rebalancing that’s warranted on each portfolio anniversary, you should ideally set up a simple checklist of ‘tripwire’ triggers that will signal the need to rebalance your investments. You could consider increasing or decreasing your equity allocation based on the financial ratios.
Timing for Portfolio Rebalancing
The 5% Rule
This ‘rule’ suggests that investors rebalance when any part of the portfolio drifts beyond 5% of its target range. For example, if equities are meant to comprise 40% of the portfolio, one would consider rebalancing if they exceed 45% or fall below 35%.
Tax-Loss Selling
If one has a taxable investment account, it might be beneficial to rebalance near the end of the year. This enables the utilisation of any losses to offset gains, potentially reducing the taxes owed.
Regular Reviews
Regular evaluations, whether on an annual, monthly, or quarterly basis, should be tailored to individual preferences and market dynamics. In periods of heightened market volatility, more frequent rebalancing may be advisable to align with the evolving conditions.
Conclusion
In essence, portfolio rebalancing is a critical practice that involves realigning your investments to maintain your desired asset allocation. Whether done systematically on set dates, prompted by life-stage changes, or strategically timed for tax benefits, rebalancing ensures that your portfolio stays in sync with your financial goals and risk tolerance. By periodically assessing and adjusting your investment mix, you can navigate market fluctuations, optimise returns, and sustain a well-balanced and resilient portfolio over time.