
After constructing a portfolio to suit an investor’s unique investment objective, the on-going maintenance of his portfolio thereafter remains vital to ensuring that his portfolio continues to be in line with his objectives! This is where the act of rebalancing plays an important role and in this section, we look to provide a better understanding of rebalancing!
What Is Rebalancing?
Rebalancing is the realigning of weights of the constituent assets in a portfolio. This involves new purchases and redemptions or selling of assets so that asset weights in the portfolio are maintained in accordance to the investor’s target asset allocation.
Why Rebalance?
As previously suggested in Forming A Portfolio, an investor may consider allocating about 10-20% of his investment portfolio to his supplementary portfolio (which comprises of higher risk and more narrowly-focused assets) while maintaining at least a 80-90% weight for his core portfolio (more broadly-focused assets that would result in better overall portfolio diversification). While this suggestion would likely enable the overall investment portfolio to state relatively good volatility levels given the much larger weight allocated to the core portion of the portfolio, over time, the changes in the performances of the assets in a portfolio would no doubt result in a change in the portfolio’s asset allocation despite the investor not altering the weights himself! This is as financial markets do not move in tandem or in similar fashion and no single market will be the best performing market forever and vice versa. Thus, this results in asset weights that differ from their targeted weights, leading the portfolio to deviate from the investor’s investment objective. Therefore, rebalancing no doubt remains an essential component in portfolio management!
Another reason is that the method of rebalancing will eventually result in one buying assets when they are cheap and selling assets when they have risen in price. Ultimately, this would allow one to slowly take profits from expensive markets and add to cheap markets, putting one in a position to benefit from both market corrections as well as market re-ratings!
How Often Should One Rebalance One’s Portfolio?
While there is no fixed time frame for rebalancing, a guideline would probably be once a year or semi-annually.
The mistake of not reviewing investments regularly enough is one of the common investing mistakes investors are guilty of. In view of the importance of rebalancing in effective portfolio management, we advocate that investors remind themselves to maintain investment discipline and focus on their investment objectives and horizon whilst keeping an eye on valuations when determining the appropriate asset allocations! After all, given that periodic rebalancing leads an investor to ultimately buy low and sell high, it is unsurprising if rebalancing gives rise to higher returns in the long run as compared to a buy and hold strategy!
