Portfolio rebalancing strategies

2 min read

portfolio rebalancing

In this age of lots of financial risk and uncertainty, portfolio rebalancing should be the priorities of every financial institution, banks, and individual investors. A lot of approaches to portfolio diversification has been suggested in the literature. And that combines the risk and returns in the optimization problem. But there have been very few reviews for investors to learn how to rebalance a portfolio. A portfolio which is a collection of many investments and/or financial assets such as the stocks, bonds and cash can be held by any individual investor and/or managed by the financial professionals, hedge funds, banks and other financial institutions.

The act of rebalancing portfolio is an action usually carried out by financial investors to bring back into line a portfolio that has deviated from the target asset location. Most times, the investment in a portfolio will always perform according to the market that has times goes on, a portfolio current asset location will drift away from an investor’s original target asset location. If this is left unadjusted, the portfolio will either become too risky or too conservative. Rebalancing portfolios by investors to get a balanced portfolio is a concave strategy that requires consistency and a lot of commitment in it. The reason investors aim at rebalancing portfolios is to move the current asset allocation back in line to the originally planned asset allocation.

We can say that a balanced portfolio is a realigned weighting of a portfolio or asset. When rebalancing a portfolio, buying and selling the asset in the portfolio to maintain the original or desired level of asset allocation or risks periodically is involved. For example, if the desired target asset allocation by a financial institution happens to be a 50% stock and 50% bonds. If the bond performs well during the period, it could have increased the bond weighting to 70% and for the financial institution to get the portfolio back to the original target allocation of 50:50. The financial institution will have to sell some bonds and buy more stocks.

There is no fixed allocation for any target asset to be placed on as it all depends on the choice of the investor. The primary aim of rebalancing portfolio is to protect any investors from being exposed to undesired risk. Another aim why investors carried out this concept is to ensure that the portfolio exposures within the area of the manager expertize.

There is no specific schedule for rebalancing a portfolio. However, it is advisable to periodically examine asset allocation at least once a year. The idea of rebalancing portfolio is quite simple but the timing and frequency of rebalancing can have some strategies into the process. There are several strategies in rebalancing a portfolio in order to restore the original target allocation or risk level over time.

These strategies include:

  • The buy and hold strategy (outperforming in the up-trending market)
  • The constant mix (outperforming all other strategies in the oscillating market)
  • The constant proportional portfolio insurance
  • The maximizing share ratio

However, this portfolio rebalancing strategy incurs more transaction cost and task liabilities to the investor or the financial institutions, but yet, they still work as a risk-minimizing strategy for the investment. Periodic rebalancing is a key to maintaining your portfolio target allocations and a sound strategy for reducing risks in investment. Many investors desire to get more serious about their investment to maintain a balanced portfolio. At times, we have to properly select the portfolio rebalancing strategy that is most suitable for your investment just like the way you select the portfolio target asset allocation that you consider most suitable. A balanced portfolio is important in every investment and should, therefore, be a priority of every investor. It has a way of influencing the bridge between your profit and your loss.

No investor would pour his resources into a business without having a high expectation on it to yield a positive return. Hence, the need for every investor to stay within its area of manager expertise and avoid unexpected and undesired risk attacking the target asset allocation. A balanced portfolio ensures the safety of the investors targets asset allocation at all times.

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