Rebalancing Strategies for your investment portfolio

It is not enough to diversify your investment portfolio and spread your risk across various sectors or risk levels; you must be able to keep it up.

This is because given the volatility of most investments, there will always be changes made to the balance of your portfolio and this is where rebalancing comes in.

Rebalancing has to do with realigning the weight of any portfolio or assets. The process consists of periodically buying or selling assets in a portfolio to keep to the original asset allocation.

Investors typically desire a particular level of risk exposure and it is generally up to the portfolio managers to stick to the client's preferences and restrictions.

Rebalancing portfolio is necessary to shield investors from unnecessarily high levels of risk and the process also makes sure that the portfolio exposures do not exceed the manager's area of expertise.

While there are various types of rebalancing strategies employed by investors, two main forms are the Calendar Rebalancing and the Percentage Rebalancing.

Calendar Rebalancing

This is the most basic rebalancing strategy. Just as the name implies, it involves assessing the investment holdings contained in the portfolio at specific time intervals, already agreed on by the investor and the manager.

At the predetermined time intervals, the assets in the portfolio are adjusted to the original percentages. The time intervals are usually monthly or quarterly, as a weekly time interval would prove to be too expensive, while a yearly one would cause a wide drift in the portfolio.

To decide on the perfect time frequency for rebalancing, available drift, time limitations and costs of transaction need to be carefully considered. Calendar rebalancing strategy consumes significantly lesser time than other strategies, and so it is usually the most preferred.

Percentage Rebalancing

This is another preferred rebalancing strategy. It is slightly more complicated than calendar rebalancing, as it involves a more detailed process. Percentage-of-Portfolio Rebalancing involves a rebalancing schedule which focuses on the permissible percentage composition of assets in a portfolio.

This strategy allocates a target weight for any asset class and a tolerance range for the target weight. So, whenever the target weight jumps outside the permissible range, the whole portfolio is rebalanced to adjust to the original target percentage.

For example, if you have a target of 60% fixed income securities and 40% stocks and other riskier assets, even if stocks increase to 55% of your portfolio, there must be a rebalance to the original level.

This balancing technique is also known as the corridor method. The corridor refers to the tolerance range which would be the plus or minus 5% or more for each asset class. This means that after the target weight has been set, the permissible allowance, which is usually at this rate is the tolerance range.

For example, asset classes with higher costs of transaction will need a wider corridor range to reduce the impact of the costs of expensive trading.

Whatever the case may be, rebalancing gives the passive investor an opportunity to get back in line with the portfolio strategy and ensure that the investment objective is clear at all times.

Written by Lawretta Egba.