Portfolio rebalancing is a system in which you manage the relationship of asset classes following an important change.
It is putting back your portfolio back to where it belongs when it does not serve your plan well anymore.
For example, you have this kind of situation:
• Stocks worth 60% – $60, 000.00
• Bonds 30% – $30,000.00
• Cash 10% – $10,000.00
• Total of 100% =$100,000.00
So the here, the dollars and the percentages match.
Some of your stocks get burned without your knowledge; your portfolio would then look this way:
• Stocks worth 65% $78,000.00
• Bonds 30% $36,000.00
• Cash 5% $6,000.00
• Total of 100% =$120,000.00
You might think that there is no problem since you earned $20,000.00.
This is actually good. But, the problem enters when the investor realizes that the percentages are different and the asset allocation is different from planned making him more vulnerable to risk than necessary.
You can sell some of your stocks that ran u just recently and use your profits for cash and bonds until you gain back your original target percentages.
Review other stocks and those who do not perform well could be sold. The earning from it could then be used as investment to the other asset classes.
You could also add up new money to make your portfolio balanced and smooth its way along with your plans.
There is a reason why percentages are planned and designed in a certain way. That reason is to generate the best return at an acceptable or minimal risk. If you let the percentages roll, you are actually making the investors greatly vulnerable to risks.
It is a hard and fast rule that when there is a drift of 5% in the assets, the portfolio holder should rebalance.
Notice your Stocks
Rebalancing is not only done in the general portfolio. It is also done in the microstructures—the stocks.
For example, the stock portion looks this way:
• Large capital growth stocks 55%
• Utility Stocks 25%
• Technology stocks 15%
• Foreign stocks 10%
When foreign stocks takeoff largely, you will then be confused on what to do. Would you sell your winning stocks to purchase of other categories and balance your portfolio?
Another alternative is to juggle off your money. You place more at other categories so as to increase their percentages and rebalance you portfolio.
What would happen if you would not do anything?
Take into consideration the events that happened back in the 1990s when the technology stock skyrocketed. It did not only make the tech stocks boom out of reasonable allocation, it also tempted many people to sell off their stocks for them to buy tech companies.
Back in March of year 2000, the market dropped and made the investors who spent their money on technology companies fall back on nothing because of great disproportion in the portfolio percentages.
Portfolio rebalancing is essential in making your plan work. Portfolios should be reviewed quarterly for rebalancing and quite more often if there is an important change in the loss and gain of any asset class.