Why It’s Important to Rebalance Your Investment Portfolio

Investment is largely regarded as a way to create passive income. While people tend to fixate on what to invest in, many overlook the process of rebalancing your existing investment portfolios. This misstep could result in people making investments at higher or lower risk than they intended at the start.

You could construct your portfolio yourself, or engage a professional fund manager or stock broker to help you, for a fee.

But first, let’s get into the basics.

What is an investment portfolio?

An investment portfolio consists of a mix of asset classes comprising equities, fixed income, alternative investments, and in some cases, even real estate.

(Read more: Investment Asset Classes Explained)

Depending on your risk profile and goals, you would typically invest into different asset classes, at different allocation levels. This offers a balance between riskier and more stable returns.

You don’t have to stick to these allocation levels indefinitely however—as markets change, you can make adjustments to maximise your portfolio’s returns. These adjustments will also help you hedge risks over time.

Why is portfolio rebalancing important?

Hold it … hold it …

Over time, your individual asset classes will perform differently, and can result in your allocation changing.

For example, this person below has a balanced risk appetite portfolio, and asked for a 50-50 split between equity and bonds. They invested $1,000 at the start.

Fund/Stock Unit Price Units Purchased Amount invested Percentage
Equity $1 500 $500 50%
Bond $2 250 $500 50%
Total $1,000 100%

After a year, the both assets have performed differently and the portfolio ends up looking like this:

Fund/Stock Unit Price Units Purchased Amount invested Percentage
Equity $1.40 500 $700 57%
Bond $2.1 250 $525 43%
Total $1,225 100%

The asset allocation after a year has deviated from the person’s initial plans. The current portfolio has become riskier than before, with the equity asset taking up 57% instead of the prescribed 50% that the investor was comfortable with.

This is where rebalancing comes in. If this is not done, a sudden dip in the unit price of the equity asset will result in a larger loss ascompared to a portfolio at the 50-50 split.

How should I rebalance?

Begin by letting go of asset classes that are performing well, and purchasing investments that are not. This may sound counterintuitive, but it is key to managing risk.

Selling assets that have possibly already reached their peak would allow you to cash in on those gains and free up funds to purchase other assets that may be lower in price and primed for growth.

Different ways to maintain a balanced portfolio

Some may choose to invest on their own, and some go through brokers or investment managers.

If you choose to do the investing yourself, you would have to set up an e-trading account or go through a broker to make your investments. If you have an existing pool of investments, start off by checking if the initial growth of your portfolio is off-target.

If so, consider selling off the assets that have outperformed the growth target, and purchase asset classes that have underperformed. Doing it yourself also means you have full control over what assets to purchase, sell, and when to do so.

The downside of this method is the lack of professional management advice and access to a wider pool of investment assets that are otherwise available through other methods. For instance, certain stocks are only open to institutional investors, or out of reach for most individuals’ budgets.

Alternatively, you can use unit trust fund managers, through whom you would buy into funds with fixed asset allocations. Unit trust funds are a mix of investments across asset classes that are held under a trust deed, also known as a mutual fund.

The advantage of unit trust funds is the access to a wide variety of asset classes that you might not typically have access to due to lack of capital. Through a unit trust fund, you can invest into an existing pool of risk-optimised asset classes and securities.

Robo-advisors have also grown in popularity

In recent years, robo-advisors have also grown in popularity. The main draws to them are first the low minimum capital to start, which could be as little as $100 per month. They also tend to charge lower management fees, of around 0.5% to 1% per year on average.

These systems utilise algorithms to systematically buy and sell assets according to your desired growth targets and risk profile. Simply put, a computer watches and trades on the market’s movements with minimal human intervention.

In order to fully maximize the potential of your portfolio, we highly recommend rebalancing it regularly. Consider your options and we hope you see results on this journey!

While you’re setting money aside for investing, don’t forget to figure out how much you need to put aside for emergencies, by using Planner Bee’s emergency fund calculator.

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