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Portfolio Rebalancing: How to Keep Your Investments On Track

Wednesday, April 07, 2021 04:10 PM | Neal Farmer
Portfolio Rebalancing: How to Keep Your Investments On Track

Balancing your portfolio is an extremely important step to reaching your long-term investment goals.

Depending on what that goal is, your portfolio can be more heavily weighted in certain sectors, industries or even individual stocks. A younger investor with a longer time horizon may be able to accept shorter term volatility in hopes that the increased risk will lead to higher returns over time. Conversely, an older investor with a larger portfolio may be more focused on maintaining that wealth and decreasing risk so not to lose a significant amount before retirement. Every investor should want to diversify their assets so that overall risk is minimized, leading most traders to balance their portfolios across various sectors.

Again, the percentage allocated to each investment depends on your goals so that a growth investor may have more assets devoted to small tech companies while wealth preservation investors have a large position in defensive non-cyclical stocks such as Costco (COST).

Once investors find the right balance of their portfolio it's time to just set it and forget it ant let those assets appreciate right?


One of the biggest mistakes investors make is not periodically rebalancing their assets. A portfolio is balanced at the time of creation but markets are always moving and the percentage allocated to each asset is changing with markets.

Why Do I Need To Rebalance?

The simplest way to think about this is the investments that are winning are increasingly taking up a larger share of the investment pie while the losers are becoming a smaller portion. If an investor has a portfolio perfectly split between Microsoft (MSFT) and General Motors (GM) at the start, then if MSFT shares rise the next day while GM falls the portfolio will be more heavily allocated to MSFT. The portfolio isn't balanced based on shares but on shares times price so now the next day the investor has more invested in Microsoft and less in General Motors.

Some investors may think this is acceptable since the portfolio is becoming increasingly weighted towards the "winners". However, the benefits of diversification will slowly be lost as the allocation of investments becomes more heavily skewed towards strong performers. Additionally, the "losers" that have lagged behind may very likely be the next ones to move. This can be seen in the case of tech companies that outperformed the market in response to the coronavirus pandemic but lagging sectors such as financial services and industrials have recently outperformed with the economy reopening and vaccines being distributed.

How Do I Rebalance?

As long as the goals remain the same and the original balancing of the portfolio remains optimal, then investors should make sure to rebalance their portfolio frequently. For some that might mean rebalancing annually while others may want to do so every few months depending on risk management.

The easiest way to approach this is to essentially sell the winners and buy the losers to get back to the original allocation of investments. Traders should approach this by thinking about if they were making a portfolio today how would they want to allocate their portfolios. If some positions are larger than desired, then portfolio managers should consider selling part of that position that has likely done well since the last rebalance. Conversely, allocations that are smaller than expected should likely be bought as they have probably underperformed recently but may be primed for a rebound.

What Are The Benefits of Rebalancing?

The two biggest benefits of rebalancing a portfolio is it provides diversification and a little bit of sector rotation. The diversification will help minimize overall risk to the portfolio. Overly large positions pose outsized risks should something bad happen to a particular stock or section of the economy. Meanwhile, sector rotation is typically thought of as moving towards certain sectors depending on the market cycle as investors move to defensive stocks in bearish markets and cyclical ones during a bull run, for example. Investors may not be deliberating trying to rotate into sectors when they rebalance portfolios but the reallocation naturally leads to investing in stocks that have underperformed and are lagging behind. These very stocks or ETFs have a strong chance to be the next ones to gain ground as market conditions change and investors move to the assets if they believe they are undervalued and are the next ones to rise.

Wrapping Up

Finding the right balance in your portfolio can be extremely challenging with the sheer amount of investments to allocate between. Besides just sectors or industries, investors need to think about allocations between stocks, bonds, and cash. Periodically checking your investments and rebalancing allocations is a great way to keep the benefits of diversification and sector rotation to keep you on the path to reaching your goals.

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