Posted in:

What is rebalancing?

Imagine you’re driving to work after the weekend. You’re going a new route your colleague’s been raving about, but an unexpected traffic jam alert comes through on Google Maps. You’ve got three options: follow the original directions and be late, take Google’s new suggested route, or pick a new one yourself.

Things change, and may do so unexpectedly. The important thing is how you react to these changes.

Whether it’s smaller day-to-day decisions about getting to work, or bigger plans on how to grow your wealth for your future, there are times where you stray from your plans and have to make choices to adjust to the new conditions.

One example of this lies in rebalancing the assets in your investment portfolio.

What does rebalancing mean?

Rebalancing a portfolio means changing the composition of the investments within it to better reflect an investor’s risk level and the surrounding market conditions. In practice, a series of trades take place to change the proportion of assets within the portfolio.

For example, a less risk-averse investor has a £10,000 portfolio that’s split 70% equity and 30% bonds. After a particularly strong period for the equity market, the portfolio’s shares are up 10%, but a trickier bond market has caused its fixed income investments to fall 10%. The portfolio has strayed from its target and so asset allocation will is now be split as 74% equities and 26% bonds. The investor may then choose to sell off some of its equity to buy more bonds and bring the portfolio back in line with its original composition.

How to manage a portfolio

The continuous process of asset redistribution is crucial for strategic asset allocation – an approach that involves setting target portfolio allocations for each asset class based on an investor’s risk profile. When markets change new opportunities may rise, making tactical asset allocation especially important.

However, asset allocation isn’t easy and takes serious skill and expertise. After knowing your risk tolerance, you need to outline your allocation targets to best reflect this and construct a portfolio that builds on these investments while providing the desired returns.

At Moneyfarm all of our portfolios have allocation targets that are consistent with each investor’s risk tolerance.

Rebalancing is as important to your financial wellness as the investment decisions you make when you first set up your portfolio. It’s a continuous process that shouldn’t be overlooked or rushed, and that can get investors a step closer to reaching their financial goals when performed with the right expertise. 

Rebalancing is what allows you to choose the route you need to get to work on time.

Photo by Aaron Burden on Unsplash

Did you find this content interesting?

You already voted!