What is 'Rebalancing'

Rebalancing is the process of realigning the weightings of a portfolio of assets. Rebalancing involves periodically buying or selling assets in a portfolio to maintain an original desired level of asset allocation.

For example, say an original target asset allocation was 50% stocks and 50% bonds. If the stocks performed well during the period, it could have increased the stock weighting of the portfolio to 70%. The investor may then decide to sell some stocks and buy bonds to get the portfolio back to the original target allocation of 50/50.

BREAKING DOWN 'Rebalancing'

While the term "rebalancing" has connotations regarding an even distribution of assets, a 50/50 stock and bond split is not required. Instead, rebalancing a portfolio involves the reallocation of assets to a defined makeup. This applies whether the target allocation is 50/50, 70/30 or 40/60.

Often, these steps are taken to ensure the amount of risk involved is at the investor's desired level. As stock performance can vary more dramatically than bonds, the percentage of assets associated with stocks will change with market conditions. Along with the performance variable, investors may adjust the overall risk within their portfolios to meet changing financial needs.

Rebalancing Retirement Accounts

One of the most common areas investors look to rebalance are the allocations within their retirement accounts. Asset performance impacts the overall value, and many investors prefer to invest more aggressively at younger ages and more conservatively as they approach retirement age. Often, the portfolio is at its most conservative once the investor prepares to draw out the funds to supply retirement income.

Rebalancing for Diversity

Depending on market performance, investors may find a large number of current assets held within one area. For example, should the value of stock X increase by 25% while stock Y only gained 5%, a large amount of the value in the portfolio is tied to stock X. Should stock X experience a sudden downturn, the portfolio will suffer higher losses by association. Rebalancing lets the investor redirect some of the funds currently held in stock X to another investment, be that more of stock Y or purchasing a new stock entirely. By having funds spread out across multiple stocks, a downturn in one will be partially offset by the activities of the others, which can provide a level of portfolio stability.

Rebalancing Frequency

While there is no required schedule for rebalancing a portfolio, most recommendations are to examine allocations at least once a year. It is possible to go without rebalancing a portfolio, though this would generally be ill-advised. Rebalancing gives investors the opportunity to sell high and buy low, taking the gains from high-performing investments and reinvesting them in areas that have not yet experienced such notable growth.

Smart Beta Rebalancing

Smart beta rebalancing is a type of periodic rebalancing, similar to the regular rebalancing that indexes undergo to adjust to changes in stock value and market capitalization. Smart beta strategies take a rules-based approach to avoid the market inefficiencies that creep into index investing due to the reliance on market capitalization. Smart beta rebalancing uses additional criteria, such as value as defined by performance measures like book value or return on capital, to allocate the holdings across a selection of stocks. This rules-based method of portfolio creation adds a layer of systematic analysis to the investment that simple index investing lacks.  

Although smart beta rebalancing is more active than simply using index investing to mimic the overall market, it is less active than stock picking. One of the key features of smart beta rebalancing is that emotions are taken out of the process. Depending on how the rules are set up, an investor may end up trimming exposure to their top performers and increasing exposure to less stellar performers. This runs counter to the old adage of letting your winners run, but the periodic rebalancing realizes the profits regularly rather than trying to time market sentiment for maximum profit. Smart beta can also be used to rebalance across asset classes if the proper parameters are set. In this case, the risk-weighted returns are often used to compare different types of investments and adjust exposure accordingly.    

RELATED TERMS
  1. Strategic Asset Allocation

    Strategic asset allocation is a portfolio strategy that involves ...
  2. Smart Beta

    Smart beta investing combines the benefits of passive investing ...
  3. Smart Beta ETF

    Smart Beta ETF is a type of exchange-traded fund that uses alternative ...
  4. Tactical Asset Allocation - TAA

    An active management portfolio strategy that rebalances the percentage ...
  5. Beta

    Beta is a measure of the volatility, or systematic risk, of a ...
  6. Dynamic Asset Allocation

    Dynamic asset allocation is a portfolio management strategy that ...
Related Articles
  1. Tech

    How to Make a Solid Annual Rebalancing Plan

    An annual portfolio rebalancing plan can preserve your original asset allocation and reduce risk while improving overall return with less volatility.
  2. Financial Advisor

    Why Investors Need to Rebalance Their Portfolios

    The best way to explain why one should rebalance their portfolio is to show what could go wrong if one doesn't.
  3. Investing

    The Importance of Rebalancing Your Portfolio

    Rebalancing benefits your investment portfolio in many ways and should be done regularly.
  4. Investing

    Is It Time to Rebalance Your Portfolio?

    Failing to rebalance a portfolio results in higher risk without higher returns.
  5. Managing Wealth

    The Role Of Rebalancing

    A disciplined rebalancing practice can add a lot of value to a long-term strategic asset allocation program.
  6. Investing

    Does Portfolio Rebalancing Produce Better Returns?

    A look at how much impact rebalancing has on the performance of a portfolio.
  7. Investing

    How to Renew and Adjust Your Portfolio

    Our complete guide to rebalancing your portfolio will make sure that you maintain your strategy and maximize your returns.
  8. Investing

    Rebalance Your Portfolio to Stay on Track

    Like a tune-up for a car, this realignment should minimize trouble down the road.
  9. Financial Advisor

    Top Portfolio Rebalancing Software for Advisors

    Portfolio rebalancing software has grown in popularity among advisors in recent years. Here's why and a look at some of the most popular solutions.
  10. Tech

    Are Your ETFs Losing Money? It Might be Time to Rebalance

    Learn how disciplined rebalancing of your assets can help your portfolio perform better in the long term in good times as well as bad.
RELATED FAQS
  1. How do I know when to "rebalance" my investments?

    In order to have a disciplined approach using "rebalancing style" investing, you must first setup a defined model that specifies ... Read Answer >>
  2. How often do target-date funds rebalance?

    Learn about target-date funds and how they begin rebalancing their portfolio 20 to 25 years before the target date as an ... Read Answer >>
  3. What is the difference between a smart beta fund and an index fund?

    Smart beta funds and index funds differ in how they are constructed. Read Answer >>
Hot Definitions
  1. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  2. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  3. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  4. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
Trading Center