What is Portfolio Rebalancing?

Investment portfolio rebalancing helps keep your investment portfolio on track, keeping the risks under control and potentially offering additional returns. In this article, we will answer the question, what is portfolio rebalancing, the benefits of rebalancing portfolios, and portfolio rebalancing best practices.

What does rebalancing your portfolio mean?

Portfolio rebalancing is the process of realigning the weightings of your investment portfolio assets.

Over time, the value of assets can fluctuate due to market movements. This can cause your investment portfolio to drift from its original allocation.

Rebalancing involves buying or selling assets in order to restore the portfolio to its target allocation.

What are the benefits of rebalancing portfolios?

Providing it is done carefully and under the close supervision of a professional investment management specialist, there are various potential benefits of portfolio rebalancing.

Maintaining desired risk levels

Rebalancing can help maintain the desired level of risk within your portfolio. As some assets grow faster than others, they can increase the overall risk if they are not adjusted.

For example, if equities outperform bonds, your portfolio may become more equity-heavy, which will increase your risk exposure. Portfolio rebalancing in such cases can help ensure your risk profile remains consistent with your risk tolerance and overall financial objectives.

Optimising returns

Regular portfolio rebalancing can potentially enhance returns. The practice forces you to sell high-performing assets and purchase underperforming ones. This creates a ‘buy low, sell high’ strategy which can help optimise long term returns.

Preventing emotional investing

Portfolio rebalancing encourages disciplined investing by sticking to a pre-defined strategy. This reduces the likelihood of making emotionally-based decisions based on market volatility, and helps avoid the pitfalls of market timing and speculative trading.

Capitalising on market opportunities

Regular reviews of your investment portfolio will allow you to take advantage of new investment opportunities and market conditions.

This proactive rather than reactive approach keeps your portfolio aligned with your changing financial goals, as well as with market trends.

Rebalancing portfolio example

It is often helpful to look at a rebalancing portfolio example to see how it could potentially work in action for you.

Say you have a target allocation of 60% equities and 40% bonds. Over time, due to market performance, your portfolio drifts to 70% equities and 30% bonds.

This is how you may potentially be advised to rebalance:

Assess current allocation:

Value of current portfolio: £2,000,000

Equities: £1,400,000 (70%)

Bonds: £600,000 (30%)

Determine target allocation:

Equities: 60% of £2,000,000 = £1,200,000

Bonds: 40% of £2,000,000 = £800,000

Rebalancing strategy:

Sell £200,000 of equities

Buy £200,000 of bonds

Following the rebalance, your portfolio will return to the target allocation of 60% equities and 40% bonds, maintaining your desired risk level and sticking to your original investment strategy.

Best practices for portfolio rebalancing

There are various best practices for portfolio rebalancing that are advisable to stick to:

Set a rebalancing schedule

Put a regular portfolio rebalancing schedule in place. This could be, for example, yearly, half-yearly or quarterly. Consistent rebalancing will help prevent considerable target allocation drift, and will support disciplined investing.

Use threshold-based rebalancing

In place of time-based rebalancing, think about rebalancing your portfolio when your asset allocations deviate by a certain percentage from their targets, for example 5% or 10%. This approach is more dynamic and works more responsively to market conditions.

Be mindful of transaction costs and taxes

Portfolio rebalancing will inevitably attract transaction costs and taxes. Frequent trading can incur high costs and tax liabilities, which can eat into your returns. You should therefore aim to rebalance tax-efficiently, making use of tax-advantaged accounts wherever possible.

Use an automated rebalancing system

Automated rebalancing via an investment adviser can help ensure your portfolio stays aligned with your target allocation, without manual intervention. This can save time and reduce the likelihood of making emotionally-based decisions.

Review and adjust targets

It is advisable to regularly review and adjust your target allocation based on any changes in your financial objectives, risk tolerance and market conditions.

Your portfolio rebalancing strategy should evolve with your personal circumstances and investment goals.

Portfolio rebalancing – in summary

Portfolio rebalancing is an essential strategy for maintaining the desired risk-reward balance in any investment portfolio.

By methodically realigning your asset allocation, you can potentially optimise returns, reduce risk, and remain disciplined in your investment approach.

Always remember to take personalised advice from a specifically qualified investment adviser in order to implement a tailored rebalancing strategy that will provide reassurance that your goals will be met, and boost your long-term financial success.

At Partridge Muir & Warren, we have a dedicated investment management team with long term experience in portfolio rebalancing and all aspects of investment management.

Why not get in touch to arrange your no-obligation complimentary consultation? We look forward to helping you get the most out of your investments.