Investment strategy uncovered: How rebalancing works and its benefits

Julie Brownlee, Fsp Invest, 07 Oct. 2014

Tags: rebalancing, what is rebalancing, investing, investment strategy, strategy

If you’re looking for an investment strategy that instils some discipline, why not consider rebalancing.

Rebalancing forces you to act against your emotions, can increase the performance of your portfolio and reduce your overall investment risk.

So what exactly is rebalancing? How does it work? And why is it advantageous?

Let’s take a closer look…

What is rebalancing?

Rebalancing involves returning an investment portfolio back to its target allocation.

Let’s use an example to look at how rebalancing works in practice…

You have a portfolio made up of shares and bonds. You started off with 60% of your cash in shares and 40% of your cash in bonds.

The stock market goes on to perform very well. This means a year later, your portfolio now comprises of 70% shares and 30% bonds.

To rebalance your portfolio, you need to return it to its 60/40 allocation. So you sell some of your shares and buy bonds.

The benefits of rebalancing

One of the major benefits of rebalancing is it makes you disciplined. It forces you to sell investments that have done well and in the process have become more expensive.

This in turn makes you buy investments that haven’t performed as well and are cheaper.

This goes against what many investors tend to do. Investors are prone to buying the investments that are popular (and expensive) and sell what’s not performing (and cheap).

So rebalancing helps to remove some of the emotions at play when you invest. And this leads to you making more rational decisions.

Studies into rebalancing show that it can boost returns over the long-term. And it can reduce your investment risk.

But don’t be tempted to rebalance too often. Rebalancing incurs trading costs. So opt to rebalance your portfolio every six-months or every year.

So there you have it, how rebalancing works and its benefits.

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