Portfolio rebalancing means restoring the weightings of a portfolio of assets to its target allocation.
This is done by the buying and/or selling of assets to achieve a desired or recommended level of asset allocation in your portfolio.
When utilizing a long-term passive investing strategy, this would mean you would rebalance via “buying low, and selling high” throughout the course of your investment horizon.
Why is Rebalancing Important?
When investing in a diversified portfolio of various asset classes, it’s natural for a “portfolio drift” to occur. This is when your original asset allocations have shifted due to market movements.
As an example, you may have started your investment journey with a 60% equity and 40% fixed income split. Let’s say over a period of time, due to strong performance in equities, you now have a portfolio weighting of 70% equities and 30% fixed income. This is known as a “portfolio drift,” and the investor is now no longer in a portfolio aligned to their original investment risk preferences.
Rebalancing insures an investor’s portfolio is aligned to their goals and risk preferences throughout their investing journey. If you do not rebalance your portfolio, you will inevitably end up with an asset mix that doesn’t match your risk tolerance.
In short, rebalancing one’s portfolio reduces overall risk, enhances returns, and shortens the amount of time it takes for a portfolio to recover following market volatility.