1/9/2024

How to balance your trader’s portfolio

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Just like constructing a house, mastering portfolio rebalancing begins by laying a solid foundation. Initially, you need to identify your financial objectives, investment horizon, and risk appetite. With this understanding, structure a blend of financial instruments, such as stock and bond ETFs, with the guidance of a financial consultant or independently.

Here are a few criteria that every investor should know about.

Diversification Basics

The goal is not to achieve perfect balance, as market fluctuations will inevitably cause your asset allocation to deviate from your original plan. The key is to periodically check your portfolio and make adjustments as needed to ensure it aligns with your current financial situation, risk tolerance, and long-term goals.

Here are some factors to consider when rebalancing your portfolio:

  • How much has my portfolio deviated from my original asset allocation?
  • Am I comfortable with my current asset allocation?
  • Have my goals or risk tolerance changed?

 

Ways to Balance Your Portfolio

There are various rebalancing strategies:

Select the percentage range to rebalance. Percentage range rebalancing involves determining a threshold for asset class deviations from the target allocation. This threshold can be as narrow as 1 or 2%, while others prefer a broader range of 5%. The choice depends on an investor’s comfort level with deviation and the frequency of portfolio reviews.

Set a time to rebalance. Time-based rebalancing involves setting a specific interval, such as annually, quarterly, or semi-annually, to reassess and adjust the portfolio. Annual rebalancing is a common approach, but some investors prefer more frequent checks. The frequency is a personal decision, as less frequent rebalancing may allow equity allocation to grow, potentially leading to higher returns but also increased volatility.

Steps Required to Rebalance a Portfolio

Analyze. Carefully review your portfolio’s asset mix, including the percentage of stocks, bonds, and other assets.

Compare. Determine the percentage difference between your current and target asset allocations. For example, if your target allocation is 80% stocks and 20% bonds, but your portfolio currently holds 85% stocks and 15% bonds, you need to rebalance.

Sell. To sell 5% of your stock holdings, divide your current stock value by your desired stock allocation: (Current stock value) / (Desired stock allocation) = 5%. If your stock valuation is $500,000 and your desired allocation is $400,000 in stocks, sell $25,000 worth of stock investments to bring the stock value down to $425,000.

Buy. With the $25,000 from the stock sale, purchase bonds to bring the bond value up to $75,000. This will restore your portfolio to the desired allocation of 80% stocks and 20% bonds.

 

Pros and cons of portfolio rebalancing

Managing your investments, including rebalancing, demands a disciplined approach. Regularly evaluate your portfolio to ensure it aligns with your long-term objectives.

Pros

  • Minimizes volatility and risk. Rebalancing helps maintain a balanced portfolio, reducing the impact of market fluctuations.
  • Enhances portfolio diversification. Regular rebalancing ensures that your portfolio effectively spreads risk across different asset classes and sectors.
  • Protects against market downturns. A planned rebalancing schedule helps safeguard your portfolio against sudden market declines.

Cons

  • Reduces exposure to outperformers. By selling outperforming assets, rebalancing may limit your gains in those areas.
  • May conflict with tax loss harvesting strategies. Rebalancing can interfere with tax loss harvesting strategies, which aim to reduce your tax burden.
  • Requires expertise. Effective rebalancing necessitates a grasp of financial markets and the ability to make informed decisions.
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