Rebalancing Your Portfolio: When and How To Do It

Investing is a lucrative way to grow your wealth over time. However, it’s not just about choosing the right assets. It’s also about managing those assets as market conditions change. Over time, market movements can shift your original asset allocation, changing your risk profile. To stay aligned with your financial goals, you need to rebalance your portfolio regularly.

In this article, we will look at what rebalancing portfolio means, its importance, advantages and disadvantages.

What Is Portfolio Rebalancing?

Rebalancing portfolio meaning refers to adjusting the percentage of different asset classes in your portfolio to return to your target asset allocation. 

For example, suppose your original asset mix was 70% equity and 30% debt. Over time, if equity markets perform well, your equity share might grow to 80%, while debt drops to 20%. This changes your risk-return profile. Rebalancing your portfolio means selling some equity and buying debt instruments to bring it back to 70:30.

In short, rebalancing portfolio helps maintain your intended level of tolerance for risk and keeps your investment strategy aligned with your long-term goals.

Importance of Portfolio Rebalancing

Rebalancing portfolio is important because it helps you manage your investments better. Here’s why it matters:

• Keeps Risk Under Control: When your investments grow at different rates, your original balance can change. This can make your portfolio riskier than you planned. Rebalancing helps bring it back to your comfort level.
• Keeps You on Track: You invest with a goal in mind, like buying a house or saving for retirement. Rebalancing makes sure your investments continue to support that goal, without moving away from your original plan.
• Helps You Buy Low and Sell High: When you rebalance your portfolio, you usually sell some of the assets that have gone up in value (sell high) and buy those that have gone down (buy low). This can help improve your returns over time.
• Promotes Discipline: Rebalancing helps you stick to your investment plan. It stops you from making emotional decisions based on short-term market changes.
• Supports Long-Term Growth: By regularly adjusting your asset mix, you can manage ups and downs in the market and build wealth consistently over time.

Types of Portfolio Rebalancing Strategies

There are different ways for rebalancing portfolio, depending on how often you want to make changes and how closely you want to monitor your investments. Let’s look at the most popular strategies:

• Calendar-Based Rebalancing

In this strategy, you rebalance your portfolio at fixed time intervals like every three months, six months, or once a year, no matter what is happening in the market. You simply pick a date or month and review your portfolio composition on that schedule. If the value of your investments has moved away from your planned asset mix, you make the changes needed to bring it back to your target asset allocation. 

• Threshold-Based Rebalancing

This method is based on percentage changes in your asset classes. You set a limit (also called a threshold)—for example, 5% or 10%. If the percentage of any asset goes beyond this limit, you rebalance your portfolio. You don’t have to check your portfolio on a fixed date, but you should monitor it regularly to see if any asset class has moved too far from your target. 

• Hybrid Rebalancing (Calendar + Threshold)

Hybrid rebalancing combines both the calendar and threshold methods. You choose a regular time to check your portfolio (like every six months), but you only rebalance if your asset allocation has changed more than your set threshold.

• Cash Flow-Based Rebalancing

In this method, instead of selling assets, you use incoming cash flows such as dividends and interest payments to adjust your asset allocation. So, when your portfolio becomes unbalanced, you don’t sell anything. Instead, you redirect your incoming cash flows to the asset class that is lower than the target.

Each of these rebalancing strategies has its own benefits. The right approach depends on your personal goals, how much time you can give to managing your investments, and your tolerance for risk.

How To Rebalance Your Portfolio?

Rebalancing portfolio might sound difficult, but it’s manageable when done step-by-step. Here’s how to do it:

Step 1: Review Your Portfolio

Start by reviewing your current portfolio composition. Check the percentage of each asset class, like equity, debt, gold, etc.

Step 2: Compare With Target Allocation

See how far your current allocation has drifted from your target asset allocation. For example, if your target is 70% equity and 30% debt, but your current portfolio is 80% equity and 20% debt, it’s time to rebalance.

Step 3: Decide What To Buy or Sell

To rebalance your portfolio, you need to sell high and buy more of the underweighted asset. In the above example, you would sell some equity and buy more debt.

Step 4: Consider Taxes and Costs

Before selling assets, think about taxes, exit loads (if you invest in mutual funds), or brokerage charges. Choose a strategy that minimises these expenses.

Step 5: Execute the Rebalance

Make the necessary transactions to adjust your asset allocations back to the original or desired mix.

Step 6: Monitor Regularly

Rebalancing is not a one-time activity. Review your portfolio timely to ensure it matches your risk profile and goals.

Advantages and Disadvantages of Portfolio Rebalancing

The table below explains the main advantages and disadvantages of portfolio rebalancing to help you understand it better:

Challenges and Risks Associated With Portfolio Rebalancing

While rebalancing portfolio is a smart strategy, it’s not without challenges. Here are some common risks of portfolio rebalancing:

• Market Timing Risk: Rebalancing portfolio at the wrong time can lead to losses.
• Tax Implications: Selling assets can result in taxable capital gains, especially in the case of stocks or mutual funds.
• Emotional Bias: Investors often find it difficult to sell high-performing investments because they fear missing out on further gains.
• High Costs: Frequent rebalancing may lead to high transaction charges or exit fees.
• Underperformance Risk: Sometimes, rebalancing may lead you to reduce exposure to a rising asset class, which could impact overall returns.

Hence, it’s important to choose a rebalancing strategy that fits your goals and risk tolerance.

Conclusion

Rebalancing portfolio is a smart way to manage risk and keep your investments aligned with your goals. As markets go up and down, your asset mix can shift. Rebalancing helps bring it back to your planned allocation, so you stay on the right path. Whether you choose to rebalance by time, percentage changes, or through fresh investments, staying consistent is key. It doesn’t have to be complicated. You just need the right approach and tools.

Looking for an easy way to manage your investments? Try Torus Digital, a user-friendly online investment platform that helps you stay balanced and on track.