What is portfolio rebalancing and why is it needed

Why portfolio rebalancing is needed

To achieve investment goals and avoid losses. The profitability and riskiness of assets is constantly changing under the influence of a variety of events, from world news to the release of a successful product to the market. Some assets rise in value, while others fall. Such changes are critical for an investor, because he does not just buy some securities, but is guided by an investment strategy. And it must be adhered to in order to get the desired result.

Let's say an investor set the goal is “to buy an apartment in 10 years”. This is an ambitious enterprise, and there is not much time. In such a situation, it is more correct to invest money in reliable assets, such as bonds. They will not bring much profit, but they will not fluctuate much. Stocks, on the other hand, are a more risky asset: in theory, you can make more money with them, but the chances of losing money are higher.

The investor made briefcase taking into account his goal: he gave 60% of the capital to bonds, 30% to stocks, and another 10% bought several pairs of rare sneakers. A year later, the man decided to check his assets and saw that their ratio had changed a lot.

So, the share price went up. On the one hand, this is not bad: the portfolio will bring more money. However, on the other hand, due to the change in proportions, the risks increased. If an asset grows faster than others, then it becomes more volatile - its price fluctuates greatly. One day, a person may find himself at a loss due to a sharp drop in the value of a volatile asset. And instead of an apartment will be left with nothing.

Therefore, investors try to manageE. E. Qian. Portfolio Rebalancing risk and restore the proportions that were originally conceived. That is, to rebalance the portfolio - to change the shares of assets so that their ratio corresponds to predetermined goals.

How an investor can rebalance a portfolio

There are several basic strategies that can be combined depending on the specific situation.

Sell ​​profitable, buy cheaper

If the share of a particular asset has become higher than intended, investors sell the surplus and receive free money in order to purchase what has fallen in price.

Let's go back to the owner of the investment portfolio, consisting of 60% bonds, 30% stock and 10% rare sneakers. First, the man bought shoes and suitable bonds, and then bought shares of Sber, Gazprom and Yandex for 90 thousand rubles.

A year later, prices have changed and the proportions have gone astray. Shares of Sber lost 10.25%, Gazprom - 30.7%, but Yandex grew by as much as 54.9%. To restore the original shares, the investor sold part of the latter's shares.

The profit from this action was used to rebalance the portfolio. The man bought additional bonds and fallen stocks. The investor was confident in the prospects of Gazprom and Sber, so he treated the fall in value as sale - these securities should have paid for themselves later.

Receive dividends and coupons, buy in addition the fallen

As a rule, the portfolio contains dividend stocks and bonds for which coupons come. These payments can be withdrawn from the account and spent, or you can put everything back and start the mechanism compound interest. Its essence is in the snowball effect: the initial investment brings income, and then the latter gives new income. And the further, the more.

Let's say Sberbank and Gazprom paid dividends, and coupons on bonds came. Now the investor can restore the shares of the companies that have fallen in price and not sell anything. If the portfolio is large enough, of course: at the initial stage, dividends and coupons may not be enough.

Deposit additional money into the account

If an investor wants to earn more and more, then it is useful to regularly replenish the account: once a month, quarterly, year - as it is convenient. Then the portfolio will become larger and larger, which means there will be more dividends and coupons that can be invested back and increase earnings.

And free money can be used for rebalancing. This will allow restoring shares of assets and not selling anything.

When to rebalance your portfolio

There are several approaches you can take off from.

At the certain time

The easiest and most convenient method. The investor chooses in advance how often he will look into the portfolio: on the first working day of the month, on the last working day of the quarter, or at the beginning of the year. And then he puts a reminder in calendar and does not worry about investments until then.

If the investor trades frequently, for example several times a month, then regular rebalancing will not hurt. But most asset owners don't make senseBest practices for portfolio rebalancing / Vanguard Research it is too zealous to monitor the shares in the portfolio: it is optimal to check the situation no more often and no less than once a year. The main thing is to rebalance the portfolio altogether.

By share deviation

This method is more difficult, because you will have to look into the portfolio and you will have to worry more often. If the assets are very volatile, then you may need to do this every day. For example, an investor decided to give a part of the portfolio cryptocurrency ETH, which regularly rises or falls by 10-12% during the day. The proportions of the portfolio, which need to be straightened, also dangle with it. It is important here to outline certain boundaries so as not to forever chase after a changing market.

Let's say you can apply the classic “5/25” rule: rebalance if the share of an asset in the portfolio deviated by 5% or 25% from the initial one. Which trigger is triggered depends on the share of the asset in the portfolio: if it is large, then rebalancing is needed when the change is 5%, if it is small - 25%.

For example, the share of shares has shifted from 40% to 43% - it seems that nothing needs to be done. However, the ratio between specific securities has changed dramatically: Gazprom shares fell in price by 30.7%. Hence, it is necessary to sell other securities and equalize the shares.

Of course, only the investor can determine his range. Classic portfolio management tutorials offerJ. L. Maginn, D. L. Tuttle, J. E. Pinto, D. W. McLeavy. Management Investment Portfolios: A Dynamic Process build on the size of transaction fees, risk tolerance, volatility and asset correlation. Simply put, from an investment strategy.

By time and deviation of shares

This approach combines the two previous ones and, most likely, will allow the investor to save time, nerves and not lose money. profitability. Lack of rebalancing in time - shares can "move out" too much in a year. The disadvantage of rebalancing according to the deviation of shares is that it requires a lot of transactions, which means that it leads to losses on commissions.

The idea behind the combined approach is to look at the portfolio once a month or every six months, but rebalance the shares only if the trigger rule is triggered. That is, the investor does not lose sight of the portfolio dynamics, but does not spend too much time on analysis - everything is on schedule.

Good calculations doneBest practices for portfolio rebalancing / Vanguard Research Vanguard Research analysts in 2015. They took a portfolio that was half stocks and half bonds and tested it on data from 1926 to 2014. It turned out that infrequent rebalancing and a wide range do not harm profitability. Things are much worse when the shares are not revised at all.

What are the risks of portfolio rebalancing?

The main constraints that greatly affect profitability are commissions and taxes. For each purchase and sale of an asset, the broker takes commission. Small, but the more often you rebalance the portfolio, the more you will have to give. The state will also take its toll: if the investor sells the asset with a profit, then part of it will go to income tax. That is, sometimes action can cost much more than inaction and rebalancing will lose its meaning.

And also a high-quality and appropriate rebalancing will not save the portfolio, which was made by a tyap-blooper. If all assets are risky or move together, then fiddling with shares will not help balance risk and reward. It is more correct to first understand your goals, horizon, take into account risks and analyze investment options. If the investment portfolio is a house, then first you need to lay the foundation and only then do cosmetic repairs.

What is worth remembering

1. Rebalancing is a way to maintain asset shares as the investor intended. This will help manage risk and even slightly improve the return on the investment portfolio.
2. You can rebalance your portfolio in different ways: sell one and buy another, invest dividends and coupons, or simply fund your account with salaries.
3. The frequency of rebalancing depends on the investor and his preferences: it can be at least every week, or once a year. The main thing is to understand why the frequency is exactly this. And don't forget about commissions and taxes, which eat up profitability.