As markets fluctuate, the values of your investments change. Over time, this can cause your portfolio to drift from your original investment strategy. Portfolio rebalancing is the process of realigning your asset allocation to maintain the balance between risk and reward that matches your financial goals.

What is Portfolio Rebalancing?

Rebalancing involves periodically buying or selling assets in your portfolio to return to your desired asset allocation. For example, if you initially set a target of 60% stocks and 40% bonds, but stock prices rise and now make up 70% of your portfolio, rebalancing would involve selling some stocks and buying more bonds to restore the 60/40 balance.

Why is Rebalancing Important?

1. Maintain Risk Levels: Over time, some investments may outperform others, causing your portfolio to become unbalanced and exposing you to more risk than you originally intended. Rebalancing ensures that your portfolio remains aligned with your risk tolerance.
2. Lock In Gains: Rebalancing allows you to lock in gains from high-performing investments by selling them while they’re up, and reinvesting in assets that may be undervalued.
3. Disciplined Investing: Rebalancing forces you to sell high and buy low, the cornerstone of a disciplined investment strategy. It prevents emotional decision-making and helps you stick to your long-term goals.

How Often Should You Rebalance?

1. Time-Based Rebalancing: Many investors rebalance their portfolios on a regular schedule, such as annually or quarterly. This ensures that they consistently manage risk and stay on track with their financial objectives.
2. Threshold-Based Rebalancing: Some investors prefer to rebalance when their asset allocation shifts by a certain percentage. For example, if your stock allocation drifts more than 5% from your target, you would rebalance.

Example of Portfolio Rebalancing

Imagine you started with a $100,000 portfolio, with 60% in stocks ($60,000) and 40% in bonds ($40,000). After a year, stocks have risen, and your portfolio is now worth $120,000, with stocks making up $80,000. Your allocation is now 67% stocks and 33% bonds, exposing you to more risk than you originally intended. To rebalance, you would sell some of your stocks and buy more bonds to restore your 60/40 allocation.

Conclusion

Portfolio rebalancing is essential for managing risk and ensuring your investments stay aligned with your long-term goals. By regularly rebalancing, you maintain your desired asset allocation, protect against overexposure to certain assets, and enhance the potential for steady, long-term growth.