In this article, we will cover portfolio rebalancing in theory and practice.

What is Portfolio Rebalancing?

In a nutshell, the portfolio rebalancing definition is: a method to “balance” (adjust) your portfolio back to your intended investment allocation.

To talk about rebalancing your portfolio, you need to have an investment allocation target.

That would be your strategic asset allocation. It should specify how much to allocate to each asset in your investment portfolio.

In other words, you need to know much you want to invest in each asset as a percentage of your total investment money.

Let’s call this your target allocation.

Why You Need to Rebalance

You need to rebalance because, as time passes, the assets in your portfolio will fluctuate, and their individual allocation will deviate from your target allocation. 

A Practical Example

Let’s say you have $200 and your investment strategy is to invest 50% in asset A and 50% in asset B.

In other words, you allocate half of your investment money to asset A and the other half to asset B.

At day 1, you buy $100 worth of asset A and $100 worth of asset B.

Therefore, your portfolio is worth $200, consisting of 50% asset A and 50% asset B. 

So far, so good... but that will change because the asset prices will not stay the same.

Let’s say a few months later you find out that asset A went up 32% and asset B went up 8%. Then your portfolio will be worth $240 ($132 of asset A and $108 of asset B).

In such case, your portfolio and your investment strategy would be out of sync.

Your portfolio should have 50% of asset A and 50% of asset B. However, it has 55% of asset A and 45% of asset B.

But that is not what your investment strategy tells you to do. Therefore, you have to adjust your portfolio back to the 50-50 allocation. You have to rebalance it.

In our example, you need to sell $12 worth of asset A and buy the same amount worth of asset B.

Portfolio Rebalancing Strategies

Portfolio rebalancing is essential, but it can be expensive if you do it too often. I would say rebalancing once per semester or even once a year should be enough.

If your portfolio is volatile, then rebalancing every quarter might perform better. However, I would not rebalance more frequently than once every quarter. 

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About the author

Ricardo Ribeiro, PRM

Investment management professional with a career spanning more than 20 years in the financial sector. Adept at integrating market risk analyses into investment strategies. Committed to helping aspiring investors get to the next level, and to shaping the next generation of investment tools and models. Mr. Ricardo Ribeiro holds a Professional Risk Manager (PRM) designation from the Professional Risk Managers' International Association (PRMIA).

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