We have previously discussed how and why you should diversify your portfolio, which is one of the most crucial strategies for successful investing. Today, we focus on rebalancing, which is another important step for an optimized investment portfolio.
Over time, as different assets’ performance varies, your portfolio will become unbalanced. Some assets will do well, causing them to occupy a larger percentage of your investment while others may perform poorly and take up a smaller piece of the pie. Regular rebalancing is necessary to restore order. Your priorities and risk appetite will also inevitably change and you will need to adjust your portfolio accordingly so that you achieve your investing goals even if they are dynamic.
Rebalancing is actually quite straightforward and involves three steps, which we will expound below:
- Review your ideal asset allocation
When spreading your investment capital across different asset classes, you will need to decide what percentage to invest in each class. This will be determined by your investment objectives, risk appetite, time horizon and amount of capital available. Once you have decided this, all you need to do is check from time to time – about once a year is reasonable – that your asset allocation is still in line with your goals and investor profile.
- Understand your portfolio’s allocation
Having reviewed your ideal asset allocation, the next step is to understand the makeup of your portfolio. If you have invested across several different funds and industries, this information may take some time to collate, but it is crucial. Divide the value of each asset class by the total value of your portfolio to get the weightings, then compare this to your ideal allocation. Do they match? How significant is the difference?
You can go about this in a couple of ways. One approach is to sell off investments in classes that have exceeded their ideal allocation and use the proceeds from that to increase the assets that are below their required percentage. However, if you have access to more capital, consider simply investing it in acquiring enough assets in the classes that need expanding until it is identical to your preferred allocation. This way, you have increased the size of your portfolio and balanced it simultaneously.
To reiterate, you need to have a balanced portfolio in order to meet your investment goals effectively. Rebalance regularly, once annually, and after significant market movements which may impact your portfolio.
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