Time to Rebalance?
Rebalancing is the process of re-aligning the asset allocation and weightings of your portfolio. Usually, this is an annual process but it is up to the investor. The ultimate goal behind rebalancing is to return your portfolio to the baseline investment weightings as set out in your investment thesis. Your thesis doesn't need to be some formal document ( like the ones in university - oh how I don't miss that life) but just a general idea of the direction you would like your portfolio to take as well as the overall strategy (growth, value, dividend etc). The purpose of rebalancing is also to limit risk in your portfolio.
Over- time as returns trickle in - some returns on some assets may out-value returns of other assets causing your portfolio to have greater exposure to that particular holding. Rebalancing allows you to mitigate this and re-organize your portfolio.
Myth: Rebalancing is not a complete breakdown and overhaul of your portfolio. It is merely a way to just reset the holdings of your portfolio back to their determined percentages.
Let’s Look at an Example:
Now you may ask - why should I sell Stock A - it had a great year and it is positioned to outperform the market? While this may be true, remember the whole goal with rebalancing is to reduce risk. The reason why rebalancing reduces risk is because over the course of the year based on different rates of return - your portfolio may become over-exposed to a certain holding. In the above example, our portfolio is Stock A heavy. If Stock A takes a dip - our portfolio will suffer greater losses with a larger proportion invested in Stock A. Recall that also, just because a stock performed well in the past year does not mean it will do the same this year. A key question to ask yourself when you are re-balancing “is if the stock/holding will continue to reward you in the future”.
Rebalancing Frequency: It is recommended to do rebalancing once a year but you can do rebalancing whenever you see fit. The downside is - it costs money to trade in/out of holdings. From a commission standpoint - it can be quite costly (even with ETF’s) so it is something to keep an eye on as commissions can rack up quickly.
Disclaimer: All of the above is my own personal opinion. Please do your research and consult with a licensed representative when making any financial decision. Examples are for learning purposes only.
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