Rebalancing: The secret to market beating returns

Julie Brownlee, Fsp Invest, 01 Jul. 2014

Tags: rebalancing, what is rebalancing, strategy, investing strategy, rebalancing example, lower risk, better returns,

If you’re looking for a simple strategy to boost you returns, rebalancing is perfect for you. Rebalancing can improve your portfolio’s performance three-fold. So how can you do it? Let’s take a closer look at how rebalancing can work for you…

What is rebalancing?

The whole concept around rebalancing means you buy low and you sell high. One of the major advantages of this strategy is it removes your emotions out of your decisions too.

And that’s not all, rebalancing has the benefit of giving you a better chance of higher profits, even if markets fall. Not many strategies can claim that, Keith Fitz-Gerald in Money Morning US explains...

Rebalancing is buying and selling specific investments that have deviated from their original allocation. The strategy reduces your risk and boosts your returns.

Let’s have a look at an example to show you have easy it is…

Rebalancing in action

Tom has R20,000. He has R10,000 in shares and R10,000 in bonds. In other words, he has 50% of his cash in each asset class.

A year down the line, Tom sees that his shares have gained R5,000 and his bonds have shed R2,000. This change means his 50% in each asset class is now 65% and 35%.

Now at first glance this might not seem too bad as Tom’s overall portfolio is now worth R23,000. But because of the changes in his allocation, his risks have changed too. With the price of his shares rising, his portfolio is now riskier.

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If the stock market crashes, Tom is suffer more than he would have done with his 50% exposure to shares.

To get his portfolio back in balance, Tom sells R3,500 of his shares and buys R3,500 in bonds. He uses the gain from the shares to buy bonds at a cheaper price.

So there you have it, why rebalancing is the secret to market beating returns.

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