A Simple Guide To Rebalancing

Over time, the value of the stocks and funds in your portfolio will change at different rates, causing the portfolio to become imbalanced from what you started with. This is called portfolio drift and is solved by rebalancing.

A Simple Guide To Rebalancing

What Is Rebalancing?

Rebalancing refers to the process of adjusting the quantity of the assets in your investment portfolio to bring it back to its original target asset allocation. It helps investors manage their risk and maintain a diversified portfolio.

Why You Need to Rebalance Your Portfolio.

Investors should consider rebalancing a portfolio to maintain the desired level of risk over time. As assets in a portfolio increase or decrease in value, the overall risk and return profile of the portfolio can change.

Let's run through a quick example.

Imagine you have a stock in your investment portfolio that you've been holding onto for a while. Suddenly, news hits that the company has had a breakthrough and their stock price skyrockets. The small portion of your portfolio that was once dedicated to this stock is now worth much more, and as a result, it starts to make up a larger percentage of your overall portfolio. This creates an unsystematic risk.

Similarly, if a bond that was intended to provide stability decreases in value, say because interest rates are increasing, it may no longer provide the desired level of risk mitigation. This is where rebalancing comes in.

An example in data.

Let's take a look at this over the course of ten years. In the example below we have an ETF made to track world stock market indexes (URTH.US) and another ETF by Vanguard for tracking the global bond market (BND.US). When we start in 2013 we are taking the traditional 40/60 split between bonds and equities. This strategy is an industry favorite and on average provides a good measure of security on your savings.

However, from the data below, we can see that if the portfolio isn't rebalanced for the ten years the split changes drastically.

In 2023 your "safe" bond holding would make up only 20% of your portfolio while the riskier stocks/shares make up almost 80%. This is a drastically different risk profile than your intended position.

Keep in Mind While Rebalancing.

When rebalancing a portfolio there are two main themes you should keep in mind:

1. Tax Implications

When an investor sells an asset that has increased in value, they may realize capital gains, which can result in taxes owed. Conversely, selling an asset at a loss can offset capital gains and reduce taxes owed. Therefore, it is important to consider tax implications when deciding which assets to sell or buy to rebalance the portfolio.

The tax implications of rebalancing a portfolio can be significant and should be carefully considered.

2. Transaction Fees

Frequent trading and rebalancing can result in higher transaction costs, such as brokerage fees and bid-ask spreads, which can eat into investment returns.

Investors should aim to minimize these costs by carefully selecting the appropriate rebalancing method and frequency, and considering low-cost investment options, such as exchange-traded funds (ETFs) and index funds.

How do I rebalanace my Portfolio?

When it comes to rebalancing a portfolio, there are numerous strategies to choose from. In addition, there are several helpful tools and spreadsheets available to aid in the rebalancing process.

We have compiled a list of various tools and spreadsheets you can use in order to rebalance your portfolio. Check out our other article here: Tools to rebalance my portfolio.