Introduction

Over time, the investments in a portfolio can change in value at different rates. As a result, a portfolio's allocation may gradually move away from the investor's original plan.

Portfolio rebalancing is the process of adjusting investments to bring a portfolio back toward its intended asset allocation. This may involve buying or selling investments across different asset classes, such as stocks, bonds, or cash.

Rebalancing can help investors maintain a portfolio that continues to align with their investment objectives and risk tolerance. However, it can also involve transaction costs, taxes, and the risk of selling investments that have performed well.

1. What Is Portfolio Rebalancing?

Portfolio rebalancing involves adjusting the investments in a portfolio when their current percentages no longer match the investor's target allocation.

For example, an investor may initially establish a portfolio consisting of 70% stocks and 30% bonds. If stocks increase significantly in value, the portfolio could eventually become 80% stocks and 20% bonds.

The investor could rebalance by reducing some of the stock allocation and increasing the bond allocation to move closer to the original 70/30 target.

2. Why Do Investors Rebalance Their Portfolios?

The primary purpose of rebalancing is to maintain the portfolio's intended level of risk and diversification.

Without rebalancing, investments that perform particularly well can become a larger portion of the portfolio than originally intended.

Investors may rebalance to:

• Maintain their target asset allocation.
• Keep portfolio risk aligned with their objectives.
• Maintain diversification.
• Prevent a single asset class from becoming too large a portion of the portfolio.
• Adjust their investments as their financial goals change.

Rebalancing does not guarantee better investment performance. Instead, it helps maintain the structure of a portfolio over time.

3. When Should Investors Rebalance?

There is no single schedule that is appropriate for every investor.

Some investors rebalance on a regular schedule, such as:

• Quarterly.
• Semiannually.
• Annually.

Others use a threshold-based approach, meaning they rebalance only when an asset class moves a certain percentage away from its target allocation.

For example, an investor with a 60% stock target might decide to rebalance if stocks move more than 5 percentage points away from that target.

The appropriate approach depends on the investor's strategy, portfolio size, transaction costs, tax considerations, and investment objectives.

4. How Does Market Performance Affect Rebalancing?

Market movements are one of the main reasons portfolios need to be rebalanced.

If one part of a portfolio rises significantly while another declines or remains relatively unchanged, the portfolio's allocation can shift.

For example, if stocks experience a strong period of growth, stocks may represent a larger percentage of the portfolio than originally planned. If stocks later decline substantially, the allocation may move in the opposite direction.

Rebalancing can require investors to sell some investments that have increased in value and potentially purchase investments that have declined or grown more slowly.

5. What Are the Potential Benefits of Rebalancing?

Portfolio rebalancing can provide several potential benefits.

These may include:

• Risk Management: Helps keep the portfolio aligned with its intended risk level.
• Diversification: Prevents a particular asset class from becoming disproportionately large.
• Discipline: Provides a structured approach to making portfolio adjustments.
• Long-Term Planning: Helps investors maintain an allocation designed around their objectives.
• Adaptability: Allows investors to adjust their portfolio as their financial circumstances or goals change.

Rebalancing can also reduce the temptation to make investment decisions based solely on recent market performance.

Conclusion

Portfolio rebalancing is the process of adjusting investments to bring a portfolio back toward its intended asset allocation.

Because different investments perform differently over time, a portfolio can gradually become more or less exposed to certain asset classes than originally intended. Rebalancing can help investors maintain diversification and keep portfolio risk aligned with their investment objectives.

There is no universal rebalancing schedule. Investors should consider factors such as risk tolerance, investment goals, taxes, transaction costs, and changes in their financial circumstances when determining whether and when to rebalance.