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  • Writer's pictureWiseWallet

Rebalancing Explained: The Key to a Balanced Investment Portfolio


 

In our previous blog posts, we explored key topics essential for securing a better financial future through investment. We discussed the fundamentals of investing, the advantages of passive investing, and the growing popularity of passive investing in recent years. We also covered strategies for managing sudden market downturns and considerations for long-term investors during current market highs. Today we will introduce the concept of rebalancing and explain why it is helpful to maintain a balanced portfolio.

 

What? - What is Rebalancing?

Rebalancing is the process of adjusting your investment portfolio to maintain your desired asset allocation. This involves periodically buying and selling assets to ensure your portfolio reflects your risk tolerance and investment goals.


Let's consider an illustrative example. Assume that you start with a portfolio with 60% stocks and 40% bonds. Over time, stocks perform well, and your portfolio shifts to 70% stocks and 30% bonds. Rebalancing means selling some stocks and buying bonds to return to the 60/40 mix.

 

So What? - Why Is Rebalancing Important?

Rebalancing is crucial primarily for risk management, ensuring that your portfolio does not become riskier than intended. It helps moderate volatility and keeps downside losses in check during market downturns.

 

Risk Management: By rebalancing, you maintain your desired level of risk. For example, during the COVID-19 correction in early 2020, portfolios that were not rebalanced had a much higher equity exposure, leading to heavier losses. In contrast, those that were rebalanced experienced significantly smaller losses.

 

Risk-Adjusted Performance: While rebalancing is not primarily intended to boost returns, it can enhance risk-adjusted performance. By selling high-performing assets and buying undervalued ones, rebalancing is similar to a disciplined “sell high, buy low” strategy. Studies have shown that any rebalancing strategy reduces portfolio volatility and improves risk-adjusted returns compared to a buy-and-hold approach. Over the long term, rebalancing helps keep your investment strategy disciplined and aligned with your financial goals.

 

Now What?

  1. Set a Schedule - Decide how often you will rebalance your portfolio. This could be quarterly, semi-annually, or annually.

  2. Review Your Allocation - Compare your current asset allocation to your target. Identify any significant deviations.

  3. Rebalance - Sell a portion of the overperforming assets and buy underperforming ones to bring your portfolio back to its target allocation.

  4. Stay Disciplined - Stick to your rebalancing schedule and avoid making emotional decisions based on short-term market movements.

 

Concluding Remarks

Rebalancing is a powerful tool for any investor, especially beginners. It helps manage risk and can enhance risk-adjusted performance by enforcing a disciplined investment strategy. By regularly reviewing and adjusting your portfolio, you ensure it remains aligned with your financial goals and risk tolerance. Embrace rebalancing as a core part of your investment routine and enjoy the benefits of a well-maintained portfolio.

 


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