Rebalancing your portfolio and adjusting it for risk and reward can be a daunting task for some traders. As with most things in trading, sometimes it just simply looks harder. To start there are many schools of thought with regard to rebalancing and allocating a portfolio - none of which are correct since they are all subjective.
What Is Portfolio Rebalancing?
In short, it's the process of reworking the mix of investments in your account. Depending on how your portfolio performs, it will naturally need to be rebalanced over time.
This is because the better performing investments will take up more room and under performing investments will take up less. When this happens you need to sit down and again take another look at risk and reward.
Simple 4 Step Process
This is a very simple process you can use to get you on the right track. Of course there may be other ways of approaching this, and if you have some other suggestions please add them via the Facebook Comments. If you money is in one account this will be easy. If not then it'll be a little harder but you still need to do it!
1) What's your target portfolio mix?
2) Compare and contrast your current mix.
How does your portfolio mix stack up to the mix that you started with? Look for areas that are either over or under allocated and make some hard decisions on places where you can make a change.
3) Start reallocating and rebalancing.
Determine where your allocations have shifted and start rebalancing. Also, consider out right adding or removing different exposures. Maybe it was a good idea to be in Oil stocks last quarter and now it's just not favorable. And as always, make sure you aren't overexposed to one particular industry.
4) Readjust quarterly.
Revisit this each quarter (or however often you like). Pare back the parts of your portfolio that have grown considerably and direct those dollars to the investments that show better opportunity.
Too Much Can Be Hazardous
I'm a fan of reducing clear and obvious risk when rebalancing. But sometimes rebalancing can be hazardous to your portfolio. Transaction costs and taxes can really eat away at the benefits quickly. In addition, the traditional thinking is to sell some of your high performer to buy more of the under performers.
The problem is that you don't let your winners run right? You cut potentially amazing gains short to buy under performing investments. Again this is a personal preference but always something to consider.
Why Bother Anyway?
Rebalancing is all about controlling your risk. Isn't everything with trading! It's making sure that you are not overly exposed to one asset class, industry, sector and/or company. Generally speaking, you don't want to have all your money in 2 companies for example. That would be stupid.
Markets change. Sectors, industries, companies go in and out of favor. Rebalancing helps you reap the full rewards of diversification and learn to how to manage your risk.