When it comes to investing, a portfolio rebalance or rebalancing might be a concept you've heard of. It's usually within the boundaries of a professional fund manager's parlance though, and not something that many ordinary retail investors like you or I might be accustomed to.
So what is meant by a portfolio rebalancing? And more importantly, is it something we should all do?
A rebalancing act
At its core, a portfolio 'rebalancing' revolves around the concept of target allocation. In its simplest form, this involves allocating each investment in your portfolio a 'target size'. If you have 5 ASX shares in your portfolio, it might be 20% each – or 30%, 30%, 20%, 10% and 10% if you so choose. All shares are volatile to an extent, but some tend to be inherently more volatile than others. And this is the concept that rebalancing rests on.
Rebalancing intends to capture profits and mitigate losses – it's a way of automating the process of 'buying low and selling high'.
Here's how it works if you start with 5 ASX shares with the 20% target weighting. If 6 months pass, and one of your shares has appreciated in value so it makes up 25% of your portfolio, while another has lost some value and is sitting at 15%, shares of the winner are sold to return the position to 20%. The profits from this sale can then be used to pull the 15% holding back up to 20%. If you consistently follow this process, it can be a great way to easily manage the emotional difficulties of buying and selling shares.
The rebalancing methodology can be extrapolated out as well. Many investors like to use it with entire asset classes, like shares against bonds, cash or gold (e.g. 80% shares, 10% gold, 10% cash). It's relatively easy to do with ASX exchange-traded funds (ETFs) that simply track these entire sectors.
Is this strategy worth doing?
Whilst I think there are many merits to investing using a rebalancing strategy, it is by no means a perfect system. If you rebalance too often, it's likely to be detrimental to your portfolio's returns because of higher fees and taxes. Taking this one step further, it might not be worth it at all if your portfolio is relatively small.
Many investors don't like to 'sell out of winners' as well. If you had bought CSL Limited (ASX: CSL) shares 20 years ago, for example, you'd be sitting on a far smaller pile of gains today if you gave your position a haircut every 6 months or so.
Foolish takeaway
At the end of the day, it's your call as an investor whether a rebalancing strategy is right for you. It has many inbuilt advantages, particularly in the fraught area of emotional investing. But equally, it won't serve the needs of all investors and may not be the right fit for your strategy or portfolio. Over to you!
