Investing isn’t something that’s a one-time exercise. Sure, you need to put a great deal of thought into selecting the investments that make up your portfolio. But once your investment portfolio has been ideally constituted, does that mean your job is done? Surely not. Your investment portfolio needs to be analysed from time to time to check if it’s still ideally aligned with your risk-return profile. In case it no longer meets your risk profile or your return expectations, you’ll need to revise your portfolio accordingly, so it’s once again in tune with your investor profile. This is what portfolio rebalancing is all about.
Let’s get a little more into the details of this concept and see what the portfolio rebalancing meaning is, what portfolio rebalancing strategies look like, and when it’s necessary to rebalance your portfolio.
Portfolio rebalancing meaning: What is it all about?
To understand this concept better, let’s begin at the basics and see what the portfolio rebalancing meaning is. Portfolio rebalancing is essentially the method by which you, as an investor, modify the asset allocation in your investment portfolio. The need for this arises because the amount of money in each asset class keeps fluctuating as markets move and the economy changes.
Generally, portfolio rebalancing strategies involve purchasing more assets in a certain investment class or selling of some of the assets in another investment class. This is done until the original target allocation of assets is achieved once again.
Let’s look at an example to understand the portfolio rebalancing meaning better. Now, say you’re moderately risk-tolerant, so you opt for an initial target asset allocation that includes 50% equity investments and 50% investments in bonds and other debt instruments. Over time, say the stocks perform poorly, thereby reducing their weightage in the portfolio to 30%. In this case, to restore your original asset allocation of 50% equity and 50% debt, you’ll need to purchase more stocks, so the balance is restored. This is essentially what portfolio rebalancing looks like.
When should you rebalance your portfolio?
Now that you’ve understood the portfolio rebalancing meaning, it’s time to move on to the next big question – when should portfolio rebalancing be done? Typically, there are different triggers that make portfolio rebalancing necessary.
Here’s a preview of some such scenarios or situations when you need to revisit your portfolio and check if it’s still aligned with your goals.
Changes in your risk profile
When you first constituted your investment portfolio, you may have been an aggressive investor who was open to taking more risks. But with time, your risk profile could have undergone changes. You may have become less tolerant to risks, making you a more conservative investor. In such a case, with changes in your risk profile, portfolio rebalancing becomes necessary.
A new financial goal on the horizon
Over time, new financial goals may be added to your objectives. When you start a family, for instance, you will have to make room for additional goals like paying for your child’s college education. When new goals like this are added to your investment objectives, you may need to revisit your portfolio to ensure that it’s capable of meeting these new targets. If it’s not so equipped, portfolio rebalancing can help.
When you’re nearing retirement, it becomes increasingly essential to ensure that your investments are properly aligned to meet your retirement goals. Rebalancing your investments may be necessary to help you achieve that target corpus you have in mind. So, if you find yourself just a few years from the big day, check your portfolio and use portfolio rebalancing strategies to adjust the asset allocation, if needed.
Portfolio rebalancing strategies: How to rebalance your portfolio?
Rebalancing your portfolio will depend specifically on your investment needs and goals. However, a few simple steps can help you understand the process better.
1. Have a target asset allocation in place. Factor in your life goals, your risk appetite and your retirement goals to make your asset allocation aligned with your investor profile.
2. Constitute your investment portfolio based on your required asset allocation.
3. Revisit your portfolio every six months or every year to check if the assets therein continue to adhere to the original target allocation.
4. Also revisit your asset allocation target periodically to ensure that it is in tune with your life goals.
5. In case your target allocation is not met, you may have to purchase new units of some assets or sell off existing units of other assets as needed, till the right asset allocation is achieved once more.
If you’re unsure about how to rebalance your portfolio, it’s always a good idea to seek the help of a financial advisor. These experts can guide you on the right asset allocation for your investor profile, and they can help you with figuring out which assets to sell or purchase, as needed.