Portfolio Rebalancing
Solo mountaineering is among the most dangerous sports on earth, and without a minimum of three climbers there is no one to stay with the injured as one retreats for help, substantially increasing the probability of a fatality. Providing each mountaineer is experienced, without injury and fit, team climbing is safer, and, therefore, more successful than solo climbing. This principle also applies to investing, though a diversified portfolio of quality holdings can stray substantially from the initial, desired allocation as the performance of each security varies, increasing risk exposure, much like a climbing team that fails to function as a group. Systematic rebalancing periodically restores the desired portfolio allocation by reducing outperforming and increasing underperforming securities. Consider the numerous benefits and few disclaimers of this popular investing strategy:
Periodic rebalancing realigns the asset mix of a portfolio to an investor’s objective, which includes risk tolerance, income need, and time horizon, much the way a climber consistently refers to a map to stay on course.
Portfolio rebalancing assists in risk management at both ends of the spectrum: by correcting overexposure to riskier securities in a bull market and safer securities in a bear market, thereby preventing the portfolio from deviating from the appropriate risk level in either direction.
Rebalancing doesn’t guarantee loss avoidance or enhanced performance, but it can increase risk-adjusted returns by forcing investors to systematically buy low and sell high.
An investor has many tested strategies from which to choose, none of which involve acting on emotions. Regular rebalancing removes an investor’s destructive emotions from the money management process.
Systematic rebalancing has proven effective in changing market conditions by directing capital to lower valuation securities.¹
While the benefits are significant, portfolio rebalancing does have the following potential disadvantages:
Rebalancing trades can increase portfolio costs. Expenses directly reduce returns, and worse, the reduction compounds indefinitely into the future. If rebalancing, try to use a firm with little or no trading fees.
Periodic rebalancing is effective to the extent productive securities are held. Security selection is as critical to the success of this investing strategy as the selection of climbers for a Mount Everest expedition.
Rebalancing in a non-retirement account can trigger substantial, unexpected taxable gains. Integrate the rebalancing program with a tax-loss harvesting discipline to avoid this unpleasantness.
Excessive rebalancing can be counterproductive. Choose either a reasonable interval of time or the breach of a particular allocation threshold as the basis for your periodic rebalancing, and stick to it.
Think about it, and may God bless your investing efforts! Shaun.
“Give a portion to seven, or even to eight, for you know not what disaster may happen on earth.” ~Ecclesiastes 11:2
1 Smart Asset, “5 Benefits of Regularly Rebalancing Your Investment Portfolio”, November 5, 2024
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the author.
https://www.fivestarprofessional.com/spotlights/90982
Award based on 10 objective criteria associated with providing quality services to clients such as credentials, experience, and assets under management among other factors. Wealth managers do not pay a fee to be considered or placed on the final list of 2012/2022 Five Star Wealth Managers.