How Should You Rebalance Your Portfolio?

This article will take you through all the ins and outs that you need to be aware of.

Updated: May 18, 2024
Matt Crabtree

Written By

Matt Crabtree

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Having a well-diversified investment portfolio is essential to minimising any risks. However, it is normal for the value of your assets to change over time, causing your portfolio to become off-balanced.

In order to effectively employ risk management and accomplish your long-term financial goals, it is essential that you keep your portfolio stable and up to scratch. This article will take you through all the ins and outs that you need to be aware of in order to re-fortify your asset allocation and balance your investment portfolio.

What is Portfolio Rebalancing?

No matter how much experience you have as an investor, there is no escaping the inevitability of rebalancing your investment portfolio.

Portfolio rebalancing essentially means carrying out maintenance (through the use of a rebalancing strategy) on your investments to ensure that your asset allocation appropriately fits your risk tolerance and facilitates your expected returns. Here's an example of when portfolio rebalancing is needed:

If your desired asset allocation contains 70% stock and 30% bonds, you will most likely notice that your investment portfolio has shifted over time to a 75% / 25% divide. This is where rebalancing comes into play, restoring your asset allocation to meet your target ratio.

In order to successfully rebalance your portfolio, you have to handpick certain stocks or bonds to sell, and determine which asset class you should purchase. Generally speaking, when striving towards their goals, investors tend to be more dependent on stocks rather than bonds because stocks frequently outperform bonds.

An Important Note: You should only attempt to rebalance your portfolio if you are an experienced investor with extensive knowledge of finance and investing.

What Assets are Found Within a Portfolio?

Assets can be distributed across various investment vehicles (such as a brokerage account), to collectively form your portfolio. You will typically find these assets within an investment portfolio:

Why is it So Important to Rebalance Your Portfolio?

Building and maintaining a well-balanced investment portfolio that is uniquely structured to match your long-term goals is incredibly important to ensure you stay in line with your investment plan, and productively manage your finances.

To paint a clearer picture for you, here are the 4 major reasons that make portfolio rebalancing so important:

1. Reduces Exposure to Risks

Rebalancing your portfolio means re-aligning your asset classes to match your risk tolerance. 

This means letting go of certain assets that are more volatile and at higher risk, as well as diversifying your portfolio to ensure your income is not dependent upon asset classes that share the same characteristics (such as multiple assets from the automotive industry).

2. Maintains The Value of Your Portfolio

A balanced portfolio will return your investments to meet your risk tolerance and promote a stable cash flow which will reduce your losses and maintain the value of your portfolio.

3. Effective Asset Allocation

By having a balanced portfolio, you can ensure that you have suitably allocated your assets to match your investment strategy, risk tolerance and overall investment goals.

4. Reminds You to Stick to The Rules

From happy to frustrated, there's no doubt that handling money comes with an array of emotions. Rebalancing your portfolio involves sticking to a strict set of rules, that prevents your emotions from interfering with your actions as an investor. 

How Often Should You Rebalance Your Investment Portfolio?

When you choose to assess and rebalance your portfolio solely depends on your investments and movements within the market.

There is no wrong way of going about rebalancing.

However, if you are seeking some structure, it may be worth noting that the general rule of thumb is to conduct a rebalancing assessment every year.

Most investors will approach rebalancing in two ways:

  1. Having a particular timeframe (for instance, annually or monthly)
  2. Rebalancing when your target asset allocation becomes unbalanced by a specific percentage (such as 5%)

How to Rebalance Your Portfolio

Whether your rebalancing strategy is intended to target capital preservation or to facilitate growth, we can assure you that developing a strong rebalancing strategy will help get you back onto the right foot, and effectively fine-tune your portfolio so you may reach your intended goals.

In this section, we will dive into all the ways that you can efficiently rebalance your investment portfolio so that you are fully aware of your available pathways. 

Hiring a Financial Advisor

The design of a portfolio can make or break the success of your investments. This is why many investors will hire a financial advisor to help them navigate through certain components of rebalancing, such as selling assets.

By recruiting a professional advisor to assess your portfolio and form an investment plan, you are lowering the risk of your emotions clouding your judgement, subsequently ensuring that your long-term finances are healthy.

Automatic Rebalancing

Traditionally, automatic rebalancing has been a manual task performed by investors with the help and guidance of professional advisors. Nowadays, rebalancing has become a lot simpler (and cheaper!) as you can implement robo-advisors which use algorithm-focused software to equilibrate your investment portfolio.

It is common for a robo-advisor to refrain from selling your investments, and alternatively use your dividends and/or deposited cash to purchase more of an asset that you are undersized in – this strategy is referred to as ‘cash flow rebalancing'.

Rebalancing Your Investment Portfolio Yourself

Rebalancing your portfolio yourself can save you a significant amount of money that would have otherwise been spent on advisor services. Before you carry out this task, you must ask yourself the following questions, in order to fully consider whether you are ready to rebalance your own portfolio:

  • Do you have the skills and knowledge necessary to create a successful strategy?
  • Do you have enough time available?
  • Do you fully understand the complexity of your investments?

If you confidently answered ‘yes' to each of those questions, you are most likely have what it takes to take action and rebalance your own portfolio. Here are two key ways you can restructure your portfolio:

  1. Selling high-performing investments while buying lower-performing ones
  2. Utilising the cash flow rebalancing strategy

An Important Note: If you sell investments from a taxable account, you will probably be obliged to pay capital gains tax. 

The Bottom Line

The primary goal of rebalancing is to eliminate any assets that are weighing down your portfolio. Although rebalancing may be challenging at first, it is certainly worth it. Getting used to rebalance your portfolio will immensely benefit you in the long run as you will be minimising any risks which pose a detrimental threat to your finances.

It is important to always remember that so long as you are well accompanied with your risk tolerance and your portfolio is sufficiently diversified with a broad variety of assets you have some wiggle room to take greater risks, which can have rewarding effects on your long-term returns.

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