Rebalancing is the process of balancing out a portfolio by returning the asset allocation to its original values and the investor’s original risk level.
Over time, asset allocations can change according to market performance, thus changing the value of the assets and the investor’s risk level. Rebalancing involves selling or buying assets to regain the original weighting and risk level.
Rebalancing a portfolio is essential because it helps maintain your desired asset allocation, ensuring that your investments stay aligned with your financial goals and risk tolerance.
“Staying diversified and investing regularly is essential. Stock markets over a 10-year period, have always beaten inflation, so keep your head down and chat with your financial adviser to ensure your portfolio is regularly rebalanced for optimum returns.”
Risk Management – Certain assets may outperform others over time, leading to an unbalanced portfolio. Rebalancing prevents excessive exposure to riskier assets.
Maintaining Investment Strategy – If your target allocation is 60% stocks and 40% bonds, but stocks perform well and grow to 70%, your portfolio becomes riskier than intended. Portfolio rebalancing brings it back to the intended mix.
Locking in Gains & Buying Low – Selling high-performing assets and buying underperforming ones follows the “buy low, sell high” principle, helping you take advantage of market fluctuations.
Reducing Emotional Investing – Rebalancing enforces discipline, preventing investors from making impulsive decisions based on market trends.
Optimising Returns for Risk Level – Staying within your risk tolerance ensures that your portfolio is neither too aggressive nor too conservative for your financial goals.
Aligning with Life Changes – Your financial goals may change over time (e.g., nearing retirement), and rebalancing ensures your portfolio adjusts accordingly.
There are several types of portfolio rebalancing, each with different strategies to maintain your target asset allocation. Here are the main types:
Financial risk refers to the possibility of losing money or experiencing financial instability due to various factors. These risks can arise from market fluctuations, economic downturns, poor financial management, or unexpected events.
There are various types of risk, ranging from conservative risk with low growth purely to preserve capital, to moderate risk that preserves and grows capital, to aggressive growth that is high risk but offers potential high returns. An investor will choose a level of risk according to how much risk they care to tolerate.
Defensive investors tend to target capital preservation. Their investments will typically be deposit-based, but with some exposure to risk assets, in order to provide the potential for maintaining capital at, or above, inflation.
Cautious investors tend to target a modest level of growth via a portfolio of mixed assets. Their portfolios will primarily be invested in fixed interest assets, but also defensive equity and property, so as to achieve relatively stable long-term returns. In the short-term, they typically expect some volatility.
Balanced investors tend to target longer-term capital growth. Their investments will be mainly in fixed interest, equities and also some ‘alternative’ asset classes. They typically expect some volatility in return for the possibility of higher long-term returns.
Moderate Growth investors tend to target a return using a portfolio with a higher equity content and a wider geographical spread. Their investments will be predominantly in equities, with an exposure to fixed interest and property, in order to provide growth-oriented diversification. They typically accept some volatility in return for the possibility of higher long-term returns.
Growth investors tend to target long-term capital growth by adopting a higher risk level. Their investments will typically be equities, but also some ‘alternative’ asset classes, for the purpose of achieving long-term capital appreciation.
Most investors rebalance periodically (e.g., annually or semi-annually) or when asset allocations deviate significantly from targets.
Rebalancing a portfolio effectively involves adjusting asset allocations to maintain your desired risk level and investment strategy. Here’s how you can do it:
John is 50 and plans to retire at 60. He prefers a moderate or balanced risk level that will protect his retirement capital, but still offers decent growth.
His portfolio consists of 50% exposure to equity or stocks and 50% exposure to bonds. Over the last year, equities have been performing exceptionally well. This has increased the weighting or percentage of equities in his portfolio. The growth has pushed his equity percentage up to 60%, which is a higher risk than John is comfortable with. His financial adviser will sell off some equities or buy more bonds to get the weighting back up to 50/50 and back to a risk level John is comfortable with.
Leaving the balance as it is increases the equities, but also the risk of losses to John’s portfolio.
Current markets are highly unpredictable and volatile. Portfolio rebalancing is essential to maintain a diversified long-term investment portfolio.
Please note, the above is for educational purposes only and does not constitute advice. You should always contact your adviser for a personal consultation.
* No liability can be accepted for any actions taken or refrained from being taken, as a result of reading the above.
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