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The Importance of Portfolio Rebalance

When you construct your investment portfolio it is important to allocate your assets in an appropriate way. However, in the course of investing the portfolio may go out of balance. Thus, it is important to rebalance it from time to time in order to bring the proportions back into their previous rates.

A change on the proportion of stocks, bonds and cash may result in profit. However, the balance has changed, which may result in deviating from the ideal for the investor asset allocation. The latter is mainly determined by the risk tolerance of the investor. So, a change in the asset allocation may lead to the exposure of higher risk levels.

A conservative investor, who is unwilling and unable to take higher risk will immediately reexamine the portfolio and rebalance it.

Portfolio Rebalancing

The rebalancing of the investment portfolio can be done in several ways.

  1. Sell the stocks that have put the portfolio out of balance due to high increase in their value. The proceeds can be used to invest in other bonds and cash. This should be repeated until the predetermined percentages are again restored.
  2. Sell the stocks that are underperforming. The proceeds can be again used to invest in bonds and cash.
  3. Use extra money to invest in bonds and cash in order to adjust the proportions to their original level.

If you decide not to take any action you risk exposing yourself to a higher level of risk than you are willing and able to accept. The purpose of balancing the portfolio is to achieve the asset allocation that best suits your needs and financial goals.

When to rebalance the portfolio? It is generally recommended that you rebalance your investment portfolio whenever the assets deviate approximately 5% from the allocation you have determined when setting the portfolio.

Portfolio rebalance may be needed due to natural change over longer periods of time. Another reason to consider rebalancing your portfolio is if there is an abrupt change in any of the asset classes.

You should also keep in mind that you may need to rebalance the proportions within the asset classes themselves. For example one of the components of the stock class has experienced an increase. You can apply the same techniques as the ones that apply for balancing the asset classes.

What if You Do Nothing

If you are unwilling and unable to take higher levels of risk, taking no action to rebalance your portfolio may lead to restless nights.

If one of the assets grows out of proportion, a decline in this sector may lead to huge losses. The chances to compensate for these losses are significantly decreased, since the other asset classes have been overlooked by your inaction.

Finally, rebalancing your portfolio whenever the need arises is of extreme importance. This is required in order to keep up with the plan you have established so that you can reach your financial goals in a timely manner. If a significant change in your asset proportions has occurred take immediate actions in order not to expose yourself to higher level of risk than you can face.

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