There is no perfect formula when it comes to rebalancing a portfolio. In fact, there are several methods of rebalancing, two of the most common are calendar rebalancing which is done on a periodic basis and percentage of portfolio whereby thresholds are established.
Each investor has different needs or individual circumstances which can change due to several reasons. These include change in wealth, time horizon, liquidity needs, tax circumstance, change in legal consideration or unique individual needs which may arise and can lead to needed changes in a portfolio allocation. Not to mention, markets are always moving and unpredictable which can also lead to change in a portfolio’s allocation. Rebalancing ensures the portfolio remains as intended, making it essential to any investor.Â
“There is no perfect formula to construct the optimal portfolio”
Rather than scheduling an annual or quarterly rebalancing which can result in wasteful transaction costs. Consider a percentage threshold which is neither too broad nor too narrow. Try not to have the thresholds too wide that would cause lost opportunities.
Photo Credit: Markus Spiske
There is no perfect formula to construct the optimal portfolio. However, with the future being uncertain, an investor should aim to diversify their investment and not have it all in one asset class. This allows the investor to limit their risk.
Diversification and alternative investments can help hedge against unsystematic risk in a portfolio. The recommended percentage is to have between 10 to 20 percent of alternative investments in your portfolio.
Overall, rebalancing can be a complicated process but nonetheless, a necessary one. It is important to set thresholds that are not too broad or too narrow when rebalancing as it can cause unnecessary or excessive fees and it can expose the investment to extremes. Investors who do their research and ensure their portfolio is well diversified and aligned to their long-term goal are on the best track to consistent long-term growth and happiness!
