The performance of your investment is determined by how well you track and manage your investment portfolio. Maintaining an ideal risk-reward balance, diversifying your assets, timing the market, understanding when to enter and leave, and so on are some of the strategies you may use to ensure that your portfolio performs well over time and produces the expected returns. Creating a high-yielding portfolio requires time, work, the right information, awareness, and forethought. While this may not come naturally to all investors, receiving expert assistance from a financial advisor can help.
Your work as an investor, however, does not end here. Simply building a portfolio management is insufficient. It is also necessary to return to it from time to time. Portfolio rebalancing refers to the periodic modification of your investments. Rebalancing is an important element of the investment process that should not be overlooked.
Related: How to Assess and Manage Your Investment Portfolio’s Risk
Assume that when you originally built your portfolio, you put 80% of your money in stocks and 20% in bonds. Over time, your stock investments have outperformed your bond investments. As a result, the value of your stock investments would rise relative to the value of your portfolio’s bonds. This excessive change in portfolio value might have a detrimental influence on your ambitions. In this case, a gain in stock value may result in more earnings, but it will also expose you to increased risk. Similarly, bond safety and low risk will be considerably decreased, hurting the long-term stability of your assets.
Portfolio rebalancing is the process of returning your portfolio’s asset allocation to where it was when you first began investing. So, if your stock investments have gained in value, you might sell them and reinvest the proceeds in bonds until your asset allocation returns to the 80:20 ratio. Rebalancing can also be accomplished by investing new funds in bonds and restoring the ratio to its original value. You would not have to sell your investments in this situation.
What is the need of rebalance a portfolio?
Rebalancing your portfolio is important for several reasons, some of which are listed below:
- Rebalancing your portfolio keeps you from making rash judgments. For example, if the market falls and your equity assets fall in value, your initial reaction may be to sell them. However, instead of responding to the market, rebalancing your portfolio might be a better option. Because stocks fell in value, your bond investments increased in value. If you were to rebalance your portfolio right now, you would sell some bonds and replace them with lower-priced equities. When the market rises again, this might result in large winnings.
- Because the value of your assets is guaranteed to change over time, it is critical to check your portfolio on a regular basis to track its success.
- It guarantees that your risk tolerance remains constant during the life of your investments. Rebalancing assists you in balancing your risk and achieving the desired balance of stocks and bonds.
- Rebalancing your portfolio allows you to see how your money has performed and which investments are performing well. This helps you to adjust on time.
In general, you should take note of the following:
- Taking control of the situation: Portfolio rebalancing is not difficult, but it may be difficult, especially if you are a novice investor. Second, if you have a diverse portfolio of investments such as cash, mutual funds, stocks, bonds, and so on, you may find it difficult to rebalance your investments on your own. Taking issues into your own hands may lead to rash judgments that may hurt you in the long run. A lack of past investment experience or understanding can sometimes lead to rash actions. As a result, it may be prudent to seek the advice of a competent portfolio manager.
- Concentrating primarily on earnings and losses rather than risk level: Most investors regard rebalancing as fixing their portfolios. They search for losses and problems that must be resolved. While this is partially correct, it cannot be applied to all scenarios. Portfolio rebalancing may help you correct mistakes and recover from upturn losses, but it is not restricted to that. The basic goal of rebalancing is to appropriately disperse risk. As a result, rather than focusing on earnings and losses, try realigning your emphasis on your risk profile.
- Ignoring the tax consequences: Selling your investments results in tax liabilities. As a result, while rebalancing your portfolio, you must consider your possible tax burden and how it affects your overall results. A capital gain is earned when you sell your investment at a profit. Short-term capital gains are profits earned from the sale of assets held for one year or less. Long-term capital gains are profits earned on assets kept for a period of one year or longer. Short-term capital gains are added to your normal income and taxed in accordance with your tax bracket. These profits are taxed at the same rate as your regular income by the federal government. Long-term capital gains, however, are taxed at a different rate.
- False diversification of assets: When rebalancing your portfolio, make sure to include items that actually diversify your portfolio. For example, you may believe that adding bonds, such as high-yielding bonds or emerging market bonds, will lower the risk in your portfolio. Including these as a risk-reduction technique may potentially backfire. The goal of increasing bond holdings while rebalancing is to lower overall risk. However, choosing high-risk bonds may increase the risk. As a result, be cautious about where you put your money.
- Ignoring your financial goals: Keep in mind that your portfolio should always represent your long-term financial objectives. For example, if your goals are long-term and you have a lot of time remaining, you can retain a high concentration of stocks after rebalancing your portfolio. However, if you are getting close to your target, you may need to reconsider your plan. For example, if you are rebalancing your portfolio a few years before retirement, you might not want to maintain the same number of shares as previously. If your asset allocation has shifted and you are now more focused on bonds, it is best to keep this ratio because retirement is not the time to expose yourself to high-risk assets. As a consequence, while portfolio rebalancing is employed to restore the starting ratio of your stocks and bonds, the end outcome should always coincide with your future goals.
All investors must rebalance their portfolios. Whatever your eventual aim is, rebalancing your assets on a regular basis can optimize returns and decrease risk. As a result, make sure that you perform this crucial duty as and when it is required. Avoiding the aforementioned faults can help you stay on track to meet your financial objectives. If you are unsure how to rebalance your portfolio and want expert advice, you can contact a portfolio manager Sydney at Omura Wealth Advisers.