The rebalancing of investments is the action / trading strategy of bringing a portfolio that has deviated away from one's target asset allocation back into line. This can be implemented by transferring assets, that is, selling investments of an asset class that is overweight and using the money to buy investments in a class that is underweight, but it also applies to adding or removing money from a portfolio, that is, putting new money into an underweight class, or making withdrawals from an overweight class.
Rebalancing is realigning the weightings of portfolio of assets, so a person may buy or sell their assets in their portfolio to maintain level of asset allocation. In order to comprehend the concept better, let’s take an example.
Your asset location consists of 50% bonds and 50% stocks. Over time if the stocks that you have invested in start to perform well, it would result in an increase in the stock weightings up to 70%. It will be up to you if you want sell some of your stocks and get back to the allocation of 50/50.
Every year the market value of all the securities on your portfolio bring a different return that result in a change of weighting. You might have set an asset allocation strategy that would be perfect for you, but at the end of the year, you would see that the portfolio has changed due to different returns.
In layman terms, portfolio rebalancing is checking each asset allocation in order to minimize risk. So if your investment strategy has changed, you should rebalance to adjust the security in the portfolio in order to fulfill a new asset allocation.
One important fact that every investor should know is that past performances don’t determine the future. This means the assets that brought you gains last year may lead to loss in the coming year.
Now that you have learnt what rebalancing and asset allocation is, you should learn how you are supposed to rebalance the portfolio:
Keep a record of the total cost of security at the time you decide on your asset allocation strategy and the total cost of the portfolio because this will provide you a basis for comparison in the future.
Review the value of each asset and the value of the portfolio. Make sure that you calculate the weightings of the fund by dividing value of asset class by the total current portfolio value. Compare this with the current findings and see if there are any changes.
If your portfolio has exposure to risk due to the changes in the asset class weightings, take the value of portfolio and multiply the weightings assigned to each asset class. The findings will be the amount that you should be investing in order to maintain the original asset allocation.
Financial education is so important, but barely taught at all in our schools. Having resources online is great, but not if they are inaccessible to so many. Thanks 508!