Portfolio rebalancing: a pillar of financial wellness

Rebalancing your portfolio is a crucial practice for buy-and-hold investors aiming to maintain their desired risk-reward balance over time. As markets fluctuate, so do the proportions of assets in your portfolio, potentially skewing your original investment strategy.  

Why rebalancing matters 

Over time, market movements can cause your portfolio's asset allocation to drift from its target. For example, if stocks outperform bonds, your portfolio might become overweight in equities, exposing you to more risk than initially intended. Rebalancing ensures that your portfolio remains aligned with your risk tolerance and investment objectives. 

Timing your rebalancing 

There are two common approaches to rebalancing: calendar-based and threshold-based. Both methods have their advantages, and the choice depends on your investment style and the amount of time you can dedicate to portfolio management. 

1. Calendar-based rebalancing: This involves reviewing and adjusting your portfolio on a regular schedule, such as annually or semi-annually. 

2. Threshold-based rebalancing: This method triggers a rebalance when asset allocations deviate by a predetermined percentage from their targets. It can be more responsive to market changes but may require more frequent monitoring. 

Steps to rebalance your portfolio 

1. Assess current allocation: Calculate the percentage of each asset class relative to your total portfolio value. Also do this for your regional, sectoral and thematic exposures. 

2. Compare to target allocations: Determine how these current allocations compare to your target allocations. Identify any asset classes, regional, sectoral or thematic exposures that are over- or under-weighted. 

3. Execute trades: Adjust your holdings by buying or selling assets to bring your portfolio back in line with your target allocations—but be mindful of transaction costs and market liquidity. 

4. Document changes: Keep a record of the changes made. 

Common rebalancing pitfalls 

Investors may fall into several traps when rebalancing, such as: 

1. Emotional decision-making: Allowing emotions to drive rebalancing decisions can lead to poor timing and suboptimal trades. 

2. Neglecting to rebalance: This can result in unintended risk exposure. 

3. Frequent rebalancing: Over-rebalancing can lead to increased transaction costs and potential tax implications, reducing overall returns. 

4. Ignoring costs: Failing to consider transaction fees and bid-ask spreads can erode the benefits of rebalancing. 

5. Inconsistent strategy: Not adhering to a consistent rebalancing schedule or threshold can lead to haphazard portfolio management. 

6. Focusing solely on asset classes: Overlooking the need to rebalance within asset classes, such as sectors or regions, can lead to imbalances. ‍
7. Market timing: Trying to time the market when rebalancing can expose the portfolio to additional risk and uncertainty.