Glance at portfolio rebalancing strategies: Invest and Forget! – How many times have you heard this advice. What do you do if you find your portfolio underperforming after 2 years? Although investing from the long-term perspective and patience are considered virtues simple investing and forgetting may at times be harmful.
But then what can you do? The answer to this lies in rebalancing. So let’s find out what it is and what strategies can we follow while rebalancing. Read on!
What is Rebalancing?
Rebalancing of the portfolio focuses on the process by which an investor is able to restore his/her portfolio to its target allocation. Portfolio rebalancing strategies are able to bring the portfolio back to the desired asset mix.
This is initiated by divesting underperforming assets and then investing in the ones having the potential to grow in the long run.
Simply put, rebalancing an investment portfolio focuses on constructing a portfolio that fits the individual risk tolerance and investment goals.
Since it is not enough to just “set it and forget it”, investors have to make sure that the portfolio stays balanced, which can be achieved with the help of portfolio rebalancing strategies.
Since it is of utmost importance to rebalance the portfolio, this article focuses on some portfolio rebalancing strategies. Read on to find out some strategies which are used by the stock market veterans.
Portfolio rebalancing strategies help in ensuring a mix of investment assets — usually stocks and bonds – is feasible for risk tolerance and investment goals.
Rebalancing the portfolio enables an investor to maintain the desired level of risk over time. Portfolios tend to get out of balance as the prices of individual investments fluctuate.
Rebalancing of the portfolio can be done at predetermined time intervals or when the allocations get deviated a certain amount from the ideal portfolio mix.
Portfolio rebalancing strategies – What are they?
There are a few different ways that can help investors to rebalance their portfolios. An investor should take into consideration each potential method before landing on the ideal investment process.
Calendar rebalancing is the most basic strategy. Among different portfolio rebalancing strategies, this strategy occupies the first place. This approach focuses on analyzing investments within a portfolio at different times throughout the year and then making decisions depending upon where the portfolio balance is at those intervals.
Most investors prefer monthly and quarterly assessments. This is because weekly rebalancing can end up being quite expensive, and a yearly approach will result in significant changes in the portfolio.
The determination of the ideal frequency of rebalancing should be based on time constraints and the transaction costs involved in the process.
Percentage of allocation
In this approach, an investor assigns each and every asset class a specific tolerance level. When an asset class falls out of that specified tolerance level, then the need for the rebalancing of the portfolio will arise.
Let us understand with the help of an example. If an investor’s portfolio should have a 60% of its investments in bonds with a tolerance level of +/-5%, then the need for rebalancing will only take place if the value of bonds in the portfolio doesn’t fall between 55-65% of the total value of the portfolio.
A combined approach to rebalancing
The third approach to rebalancing the portfolio is to combine the 2 most common strategies of calendar rebalancing and percentage of allocation. Therefore, in this strategy, an investor needs to check in on the balance of the portfolio on a regular schedule from monthly to yearly.
However, the changes are required to be made only if an asset class falls outside of tolerance levels that have been assigned.
Rebalancing on the basis of emerging trends
This is a slightly more dynamic approach to rebalancing the portfolio. In this strategy, an investor rebalances the portfolio on the basis of key emerging trends in the market. For example, long-term bonds can become vulnerable as a result of higher rates and the need might arise to rebalance the portfolio.
There can be instances where equities become available at historically low valuations. This too calls for a strategic rebalancing of the portfolio. Alternatively, the return of geopolitical uncertainty can impact the sentiments of investors which can result in higher demand for gold.
As a result of this, gold prices can rally. These are triggers related to trends for portfolio rebalancing.
One big impact of these portfolio rebalancing strategies can be the taxes that are realized by selling off an asset class. However, there are things that an investor can do to prevent being taxed a hefty amount.
Making new contributions
Instead of selling an asset class and getting a big tax hit, investors can use the new money to buy the other asset classes into the portfolio. By doing this, they will be able to balance the portfolio and nothing will trigger a tax consequence.
This is because an investment is just being made. This is one of the best possible ways to avoid tax problems. However, it can be challenging if someone doesn’t have excess cash to make new investments.
Try using expected capital losses
If an investor is able to realize an INR20,000 gain as a result of selling an asset class, then he/she might see a hefty tax bill. However, using the loss of other investment assets can help in offsetting those gains.
As a result of this, there might not be a tax consequence. Losses have to take place during the same tax period in which the gains were made. Therefore, this strategy should be followed by investors who rely on proper planning and professional guidance.
For portfolio rebalancing, there are several triggers and different approaches to go about it. Rebalancing a portfolio should be more about implementing a system that works in the best interests of an investor. It should never be about adopting what has worked well for someone else.
At the same time, portfolio rebalancing should also focus on reviewing and making informed adjustments. In doing so, the tax and other consequences are required to be kept in mind. Using portfolio rebalancing strategies can be a good way to make sure your portfolio doesn’t become stray too far from your initial target.
The benefits of portfolio rebalancing can outweigh a number of negatives for many investors as it allows the portfolio to remain on track to meet financial goals.
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