Rebalancing is a process by which an investor adjusts the proportions of assets in their investment portfolio. These changes are often done to retain a certain level of risk or return. Over time, the value of some assets might increase while others decrease which changes the overall risk and return profile of your portfolio. Without rebalancing, your portfolio may no longer align with your investment strategy, goals or risk tolerance. So, rebalancing ensures your portfolio remains consistent with your investment plan.
Related Questions
1. Why is regular portfolio rebalancing necessary?
Regular portfolio rebalancing ensures that your portfolio remains aligned with your investment strategy and risk tolerance. Without it, some investments may become overrepresented in your portfolio due to strong performance, thereby increasing your level of risk. Rebalancing provides a systematic approach to buy low and sell high, which can improve your overall returns over time.
2. How often should you rebalance your portfolio?
Want More Financial Tips?
There’s no hard-and-fast rule about how often to rebalance your portfolio, as it depends on individual investment goals and market conditions. However, a general rule of thumb is to check your portfolio at least once a year and rebalance if it has drifted 5 to 10 percent from your target allocation.
3. What are the main strategies used to rebalance a portfolio?
Investors usually follow two main strategies for rebalancing. The first approach is calendar rebalancing, typically on a yearly or semi-annual basis. The second one is threshold rebalancing which happens whenever an asset’s weighting shifts more than a predetermined threshold, like 5%.
4. Does rebalancing guarantee better returns?
No, rebalancing does not guarantee better returns. It’s a risk management technique that helps you keep your investment portfolio aligned with your desired risk levels and investment strategy. While rebalancing may contribute to improved returns by selling high and buying low, its primary purpose is not to maximize returns but to control risk.
5. Can rebalancing lead to tax implications?
Yes, depending on the type of account for your investments, rebalancing can lead to tax implications. If you sell investments that have increased in value in a standard brokerage account, you could have a capital gains tax liability. But in tax-advantaged accounts, like a 401(k) or IRA, taxes on rebalancing can be deferred or even avoided entirely.