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Rebalancing Your Assets

Rebalancing is an asset maintenance procedure. It involves assessing your investment time horizon, risk tolerance and financial need to determine whether your investment preferences have changed.

If they have, you need to assess and update the assets of your portfolio so that they may reflect your new allocation model or strategy.

If your preferences have not changed, you still have to assess and update the assets in your portfolio to ensure that they reflect your original asset allocation model or strategy.

Why Rebalance?

Over time, changes in the market may make some low-risk assets riskier and some high-risk assets less risky. If you are one of those who invest and forget, you will probably not notice such changes in the nature of your investments - and this can have disastrous consequences.

The following are the specific reasons why you should rebalance your assets from time to time.

  • To Maintain a Constant Level of Risk

    Rebalancing ensures that you are exposed to a constant level of risk - a level of risk, moreover, with which you are comfortable as you have determined when you first decided on an asset allocation strategy. Thus, you should continually trim down investments in particular asset classes (even those that are doing so well at the moment) if they are causing an imbalance in your portfolio. Your priority should and always be maintaining a constant level of risk.

    If you let your investments skew towards greater risks, you might end up losing a whole lot more than you're prepared to lose on a single market shift. Likewise, if you let your investments skew towards a more conservative risk level, you might end up earning a lot less than you expected to make in your investment time frame.

    Rebalancing, therefore, forces you to re-personalize your investment mix to reflect your own personal preferences and risk tolerance rather than go where the trade winds blow.

  • To Realign Asset Allocation Strategy to Investment Goals

    If your investment goal is to secure funds for your retirement, you should not sacrifice the long-term growth assets in your portfolio just because the conservative asset classes in it are doing better. Doing so will prevent you from achieving your long-term goals.

    If, on the other hand, you are depending on the profits of your portfolio for your day-to-day expenses, you should not exchange the security of a long-term income source for short-term gains that a current market fluctuation can bring. Doing so will increase your risk levels, and this may lead to devastating results.

    Rebalancing, therefore, is putting your long-term goals ahead of short-term gains.

  • To Adjust to a New Financial Condition or Investment Goal

    Financial needs/goals, time frames and levels of risk tolerance change over time.

    A once-aggressive investor nearing his retirement age, for example, may find that his tolerance for risk diminishes as his retirement date draws nearer. An investor who used to be all for investment growth may now be struggling to build a business and needs regular income from his investments. An investor saving up for retirement may have been recently laid off and now finds his needs changed from long-term growth to capital preservation. In each of these examples, the investor should rebalance his assets to reflect the changes in his goals, needs, risk tolerance, and investment time frame.

    Rebalancing, therefore, is realigning your assets to your current circumstances and preferences.

  • To Maintain Discipline so You Can Buy Low and Sell High

    The only constant thing in the market is change and the asset classes that are doing well today may not do so well in the future. Conversely, asset categories that are not doing so well today may well end up being the top performers of tomorrow. The top performers now are selling high, but they will sell low when they're past their prime. The future winners are now selling low, but they will sell high later on once they prove their merit.

    In this type of market, therefore, you stand to make more profit if you focus on future winners rather than chase after current top performers. This will let you buy low and sell high, thereby maximizing your returns.

    Rebalancing, by keeping you in line and true to your investment preferences and circumstances, ensures that you will not spend all of your money chasing after current market winners. Instead, it helps you keep your focus on promising investments - thus, you are able to buy low and sell high.

Why Not Rebalance?

If you believe as Peter Lynch (world renowned mutual fund manager) does that rebalancing is akin to "cutting the flowers and watering the weeds," then you probably don't and won't rebalance.

According to some investors, the following are some of the situations when rebalancing may not be for the best:

  • If the over-performing assets in your portfolio are set to grow even more,
  • If a market shift adversely affected prices but did not result to fundamental changes that would make the investment less attractive, and
  • If you have access to good information that will help you evaluate the future prospects of the asset.

When to Rebalance

When exactly do we need to rebalance our investments? Just as asset allocation strategies differ from one person to the other, there are no set time intervals in which we need to rebalance the assets in our portfolio. You can rebalance as often as you want, although rebalancing very often may not be very efficient.

The following are rebalancing schedules that some investors follow:

  • Regular Time Intervals

    Some investors rebalance their assets at set intervals (say quarterly, biannually or yearly). The great thing about rebalancing at periodic intervals is that rebalancing easily becomes part of your regular routine so it's easy to remember.

  • Asset Ratio Triggers

    Some investors set a fixed deviation percentage for the asset categories in their investment portfolios. These serve as rebalancing trigger points.

    Let's say, for example, that an investment portfolio is composed of 50% stocks, 30% bonds and 20% cash equivalents and the deviation trigger is set at 5%. The investor will know its time to rebalance if any of the categories in his portfolio goes 5% above or below its set percentage.

  • Every 15 Months

    Some investors rebalance their portfolios after every 15 months in the hopes that any asset sale done during rebalancing will qualify for long-term capital gain.

How to Rebalance

There are a number of ways to rebalance your investment portfolio based on cash/credit availability.

  • Selling investments from over-weighted asset classes and reinvesting the proceeds in under-weighted asset classes. If your portfolio's stock composition exceeds its set percentage, you can sell some of your stock assets then reinvest the proceeds of that sale in under-represented asset categories.
  • Purchasing new investments for underweighted asset classes. If the assets in an over-represented category are doing very well, you don't need to sell these assets to rebalance your portfolio. All you need to do is purchase more securities from under-represented categories. This rebalances the percentage compositions of individual asset categories.
  • Adjusting investment ratios for over-weighted and under-weighted asset classes. You can simply change your investment behavior to ensure eventual rebalancing of your assets. In other words, you should prioritize the under-weighted categories over the over over-weighted ones until you regain the right mix.
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