balance, swing, equality

Rebalancing a portfolio is the process of realigning the weightings of a portfolio of assets. It involves the process of buying or selling of assets to maintain the desired level of asset allocation or risk. A portfolio could require rebalancing due to uneven growth of the original asset allocation, or a change in desired asset allocation due to life events or simply aging. Typically as a person gets older and closer to retirement, their low risk allocation goes up so an increase in assets such as bonds goes up. Let’s take a look at scenarios when rebalancing could be a good option.

John Smith starts an investment portfolio with an asset allocation of 80% stock and 20% bonds. Over time, his stocks greatly out perform his bonds. This leads to an asset allocation of 88% to 12%. To reduce risk, he sells some of his stocks and buys bonds with the proceeds to get back to his original desired asset allocation of 80% stocks and 20% bonds.

John Smith has been investing from a young age. His portfolio has always been 100% stocks. Now he is getting closer to retirement and he would like to lower the risk of his investment portfolio. He wants to do this by setting a new desired allocation of assets of 75% stocks and 25% bonds. So he sells of 25% of his stocks and buys bonds with the money.

John Smith has a desired asset allocation of 75% stocks and 25% bonds. When John was buying stocks for his portfolio, he put 2% of his stock allocation into a new startup company he thought was promising. In a short time, that company has taken off and skyrocketed in value. His other stocks did not outperform the bonds however. This left him with an asset allocation of 76% stocks and 24% bonds. Almost his desired allocation. However, the company he invested in is now worth 10% of his stock portfolio. This is more than John likes, so he decides he needs to rebalance. He sells off enough of that company to reduce it back to 2% of his stock portfolio and puts the rest back in to other stocks. His asset allocation is still 76% stocks to 24% bonds, but now his stocks are more diversified.

You can decide when it is time to rebalance your portfolio in 2 ways. You can use a calendar schedule and just do it every set amount of time. You just don’t want to rebalance too often or you’ll offset the benefits with the negatives of things like trade fees. Or you can do it by asset drift. This is when your real allocation has drifted too far from your desired allocation.