What Is Rebalancing And Why You Need To Do It?

What Is Rebalancing And Why You Need To Do It?
Underwater by Andy Deitsch. Why?

Rebalancing is arguably one of the most important aspects of equity investing, yet it’s amazing just how many people don’t do it and lose money as a result: watch this short video to see how you can protect your profits and limit your losses

In The Uncertain Political And Economic Times In Which We Live, Rebalancing Is Vital To Keep Your Portfolio On Track

How Rebalancing Can Boost Your Wealth

Although this video is a few years old, the principles of rebalancing it teaches are as good today as they were then.

What Is 'Rebalancing?

Rebalancing is the process of realigning the weightings within your portfolio of assets.  Rebalancing involves buying or selling assets in your portfolio at a pre-determined time, to maintain your original desired level of asset allocation and risk.

By way of example, let’s assume you originally decided to hold 50 per cent stocks and 50 per cent bonds in your portfolio, to give you a good spread of investment in line with your attitude to risk.  During the period, your stocks performed well, increasing the percentage holding in your portfolio to 70 per cent.  In the same period, your bonds lost money, now representing 30 per cent of your portfolio.

Rebalancing in the example above is simply the process of selling some of your stocks and buying bonds to restore the original weighting of 50:50.  And using this example, here are the positives and negatives of rebalancing.

Three Advantages Of Rebalancing

  • Assuming stocks are higher risk than bonds, by rebalancing your portfolio to 50:50, you will have reduced your risk and reset it to your original level.
  • It’s likely you’ll be selling your stocks at a profit, protecting the gains you’ve made against a future downturn.
  • It's likely you’ll be buying bonds at a cheaper price compared to the level at which they stood initially.

Three Disadvantages Of Rebalancing

  • Your transaction costs are likely to increase as a result of you selling and buying assets.
  • It can sometimes trigger tax liabilities if your portfolio is large, though you're unlikely to face a tax bill if you’re rebalancing your SIPP or SSAS.
  • It can be psychologically stressful, for inevitably, you’ll be selling assets that are making you money and which could continue to grow.

Rebalancing often means you end up selling your assets high and buying them low, the ideal for equity based investments.  And rebalancing is something you should do whether you pick stocks yourself, or whether you invest in active or passive funds.

The Simplest Rebalancing Method

A number of different portfolio rebalancing methods exist, but there’s no clear-cut evidence that there is one system to rule them all.  There’s also no statistics to prove whether you should do it once a year, or more or less frequently.

The most important takeaway is that doing rebalancing is what counts, not exactly how you do it.

Rebalancing - A Tale Of Two Investors


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