Rebalance your portfolio

Rebalance your portfolio only when needed.

Don’t get caught up in the urge to always have the right ratios between assets.

Our portfolio needs to be rebalanced because the returns on our asset classes vary over time.

Suppose we have a portfolio that is 50% stocks and 50% bonds.
Over the past year, stocks have appreciated by 10% and bonds by 2%.
At the end of the year (assuming a total initial portfolio of €100) we would end up with €55 of shares and €51 of bonds.
55/106 equals about 52%, while bonds will weigh about 48%.
We’ll have to rebalance the portfolio. How?
By selling shares (€2) and buying bonds (€2).
In this way we will have €53 per asset class and the weights will be back to the original ones.

When rebalance your portfolio?

There are mainly 2 schools of thought on rebalancing your portfolio, according to time and according to ratio.

  • Time based rebalance involves acting on the portfolio on a periodic basis (monthly, quarterly, half-yearly, yearly,…) regardless of how investments are going.
  • Ratio based rebalance, on the other hand, occurs when the asset allocation has changed significantly.
    In other words, if the gap on the original percentage is more than 5%, 10%, 15% or 20%.
    In the previous example, the investor would have acted only when the shares weighed 55% on the total invested.

Which of the 2 is to be preferred?
The second has given better results in history, especially the one that expects the 20% difference to act.
This is because rebalancing only the 2 asset classes have substantially different weights from the original means moving after they have had their yield/loss curve.

Let’s assume a security that follows the following price.

Rebalance your portfolio

Let’s assume we follow the 20% ratio based method. As you can see from the image above (lines above), we will buy the asset when it is low (indeed it has lost +20% value in our portfolio). And similarly we would sell it when it exceeds 20% (green lines).

Always remember to keep an eye on your portfolio, but don’t get hung up on your investments.

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