Rebalancing your portfolio: What it is and why it matters

Highlights

• Investment performance is directly related to the underlying impact of markets, the evolution of companies, economies and various other macro and micro dynamic elements that affect the prices of bonds, equities and all other investment instruments available.
• Rebalancing is the act of realigning the weighting of your portfolio’s assets to maintain your desired asset allocation based on your risk appetite, while at the same time, it helps you stay on track to achieving your future financial goals in consideration of the ever-changing market dynamics.
• To rebalance your portfolio, you must periodically review your investments to maintain a balance between securities that tend to be riskier, such as stocks or ETFs and more conservative ones like bonds.
• When a large number of your current assets are held within one area, you are automatically exposed to more risk. Rebalancing your portfolio can safeguard you from being overly exposed to undesirable risk.
• Rebalancing can also lead to investment discipline and avoiding common pitfalls like timing the markets, while it may also offer you the opportunity to sell high and buy low by taking the gains from high-performing investments and reinvesting them in areas where they have not experienced notable growth.
• One of the most common strategies, periodic rebalancing is a relatively simple method, which involves rebalancing your portfolio on a predetermined schedule such as quarterly, semi-annually or annually and making adjustments so that you attain the original allocation.
• On the other hand, percentage of portfolio rebalancing involves rebalancing your portfolio only when its asset allocation has drifted from its target by a predetermined percentage or threshold of change.
• Also known as CPPI for short, constant proportion portfolio insurance sets a floor on the dollar or euro value of the portfolio, then structures the asset allocation around this decision.
• Ideally, it is recommended to reassess your asset allocation on regular intervals and depending on changes to your situation or how things are progressing in your life.
• If you’re having difficulties in rebalancing your portfolio, Calamatta Cuschieri’s experienced financial advisors can help you select the ideal strategy so that you can maintain your desired asset allocation. Get in touch to book an appointment.

From the time spent to the energy consumed and the research conducted when building your portfolio, it is often not enough to just invest your funds and let them work for you. As you manoeuvre through life, you may find yourself having to bring your portfolio back in line. A crucial component of the portfolio management process, rebalancing involves adjusting your investment holdings to adhere to your desired level of systematic risk exposure, constraints and preferences. It can also go a long way in protecting your investments.

Read on to discover what rebalancing is all about, why it matters and what are the different portfolio rebalancing strategies to use.

What is portfolio rebalancing?

If you were to set your initial allocation and leave it there to be, over time this would look very different from your intended target. This is due to the fact that certain asset classes tend to perform better than others during some cycles. Rebalancing is the act of realigning the weighting of your portfolio’s assets to maintain your desired asset allocation based on your risk appetite, while it helps you stay on track to achieving your future financial goals. To do so, you must periodically review your investments to maintain a balance between securities that tend to be riskier, such as stocks or ETFs and more conservative ones like bonds.

For instance, if you would rather have a moderate portfolio with a balance of 50% stocks and 50% bonds and opt to invest Є10,000 evenly between the two asset classes, it may possibly be the case that in five years’ time, the stocks in your portfolio may have doubled in value, which means that they are now worth Є10,000. On the other hand, your bonds may have only grown 20%, so they are now worth Є6,000. This means that your portfolio is mainly reliant on the success of your stocks. Rebalancing can help you return to your original asset allocation and one way of achieving this with in this particular case, is by opting to reallocate portion of your investments to purchase more bonds.

Why is rebalancing your portfolio important?

When a large number of your current assets are held within one area, you are automatically exposed to more risk. Should the asset your portfolio rellies most on experience a sudden downturn, automatically your portfolio will suffer higher losses. Rebalancing can safeguard you from being overly exposed to undesired risk, while you can do so in a cost-efficient and time-saving manner. However, apart from controlling risk, there are other factors that make rebalancing crucial:

• Anti-cyclical investment decisions: with anti-cyclical buy and sell signals you are more likely to reduce positions in risky assets in strong bull markets and increase them again in bear markets, which will result in better returns in the long-term.
• More investment discipline: when changes to your portfolio take place following a rebalancing strategy, then you eliminate the need for market timing and so this is the ideal method for avoiding common pitfalls when investing.
• Sell high and buy low: rebalancing may offer the opportunity to sell high and buy low by taking the gains from high-performing investments and reinvesting them in areas that have not yet experienced notable growth.

How does rebalancing work?

Rebalancing does not mean that the distribution of your assets must be split equally. In effect, rebalancing involves the reallocation of assets to a defined makeup, irrespective of whether this is 50/50, 40/60 or 70/30.

So how can you go about rebalancing your portfolio? Have a look at these portfolio rebalancing strategies.

Periodic rebalancing

Perhaps one of the most common strategies, periodic rebalancing is a relatively simple method, requiring little monitoring and oversight. It involves rebalancing your portfolio on a predetermined schedule such as quarterly, semi-annually or annually and making adjustments so that you attain the original allocation. Factors such as time constraints, transaction costs and how much you can allow any particular allocation to drift one way or another will determine the ideal frequency of rebalancing.

Percentage of portfolio rebalancing

A somewhat more intensive strategy to the one mentioned above, percentage of portfolio rebalancing requires a formulaic approach that demands frequent monitoring and it is focused on the allowable percentage composition of an asset in your portfolio. In other words, it involves rebalancing your portfolio only when its asset allocation has drifted from its target by a predetermined percentage or threshold of change. For instance, if your desired balance is 60% in bonds and 40% in stocks, you may rebalance any time the weight of your bonds shifts more than 10% in either direction.

Constant Proportion Portfolio Insurance

Also known as CPPI for short, this is a type of portfolio insurance in which the investor sets a floor on the dollar or euro value of their portfolio, then structures the asset allocation around this decision. This minimum safety reserve can be held in either cash or safer investments like government bonds. When the value of the portfolio increases, more funds are invested in equities and in contrast, when there is a decrease in portfolio worth, then a smaller position is taken towards risky assets. This type of rebalancing should be used in conjunction with other forms of rebalancing or portfolio optimisation strategies since it fails to establish how often the rebalancing should take place and instead, it just indicates how much equity should be held within a portfolio.

When and how often should you rebalance your portfolio?

Generally speaking, there’s no hard and fast timeframe as to when or how often you should embark on rebalancing your portfolio. More often than not, one of the most common areas investors look to rebalance are the allocations for their retirement. One reason for this being so is that once you are younger, you can afford to invest more aggressively, however, as you progress through life, you may need to invest more conservatively and this should be reflected in your investment portfolio. In fact, have a look at how to build an investment portfolio specifically for retirement.

Ideally, it is recommended to reassess your asset allocation on regular intervals and depending on changes to your situation or how things are progressing in your life. In this manner, you will not have to monitor every small up or down movements your investments may make, yet you will still get a clear picture of any changes that may be happening to your portfolio, which in turn will enable you to review gains or losses and make the necessary adjustments needed.

Bonus tips:

• Despite the importance of rebalancing, avoid doing so often, such as on a weekly basis. Rebalancing too frequently can come at a cost like experiencing lower returns and a heavier tax burden.
• Remember to focus on your long-term goals. Whereas short-term changes to your portfolio due to volatile markets may drive you to reconsider your investments, in reality these will have a small impact on your ability to achieve your goals.

As your personal financial situation and time horizon change throughout life, your current state may often impact how much risk you can handle in the market and this should be reflected in your portfolio. Ultimately, rebalancing is all about coordinating your appetite for risk and how much you’re exposed to it, while keeping your portfolio current with your investment goals, even as the markets change.

Generally speaking, retail investors do not have the time to constantly monitor the markets or their investments, whilst rebalancing may not be something they are confident in carrying out on their own. Calamatta Cuschieri, has you covered. Get in touch with one of our financial advisors who can rebalance your portfolio and keep tabs on your investments on your behalf.