What is Rebalancing? Find out how it works

For those investing in financial assets, building an investment portfolio is only the first step. Markets tend to change and evolve over time, with price fluctuations.

This may compromise the original strategy and may also cause financial losses. In this context, portfolio rebalancing becomes important. It means adjusting investments to bring them back to the original asset allocation.

These adjustments help maintain an appropriate level of risk and allow you to continue pursuing goals in a safer way. Let’s see what portfolio rebalancing means, how it works, the main strategies, and a practical example.

What is portfolio rebalancing?

When you start building an investment portfolio, you choose how to divide your capital among investment products, such as stocks, bonds, ETFs, commodities or other types of assets. Diversification is also important because it reduces the overall investment risk.

For example, an investor may decide to invest 60% in stocks and 40% in bonds, based on the strategy, time horizon and financial goals.

But sometimes certain assets grow more than others. For example, stocks may increase more than bonds. This directly increases the level of risk and moves the portfolio away from the original strategy.

Rebalancing the portfolio means selling part of the asset that has grown the most (in this case, stocks) and buying the one that has grown less (for example, bonds) to bring the portfolio back to the original balance.

How does portfolio rebalancing work?

In practice, the steps are

• choose where and how to invest, deciding your asset allocation
• over time, markets change, and this affects prices and the weight of each investment in your portfolio
• compare the current allocation with your target allocation and identify any imbalance
• You can decide to rebalance the portfolio by selling and buying assets to restore the original balance

In this way, you can stay consistent with your initial strategy without changing your goals or other investment factors. This process also helps significantly reduce the risk related to your investments.

Rebalancing means periodically realigning the percentages of your investments by selling assets that have grown more and buying those that have performed less well. This operation needs to be done multiple times to maintain the risk level and deal with fluctuations caused by market changes.

In the long term, this approach can improve returns, because it balances costs and gains based on which assets are performing better or worse.

When should you rebalance your investment portfolio?

There is no single perfect moment that suits everyone for rebalancing an investment portfolio. However, rebalancing is generally necessary in three main situations

• after significant market movements following a period of marked market volatility, caused, for example, by geopolitical developments or major macroeconomic changes, the portfolio may drift substantially from its original asset allocation. At this stage, it is important to rebalance the portfolio in order to avoid incurring potentially significant losses
• periodically portfolio rebalancing should be carried out regularly, by monitoring market performance and the selected assets. It is possible to proceed quarterly, every six months, or annually, depending on risk tolerance and individual circumstances
• when a specific percentage threshold is exceeded for example, action may be taken when the weighting of an asset exceeds its original allocation by 10%. In this case, the portfolio must be monitored regularly and appropriate analytical tools must be available in order to adjust effectively

Sometimes it is possible to choose a mixed strategy, but this may require a lot of time to manage investments over time and may be more expensive than other choices.

Different strategies for rebalancing your portfolio

There are several ways to implement a portfolio rebalancing strategy.

Different strategies may be implemented according to specific needs, knowing that some methodologies require more time and supervision by the portfolio manager. In any case, having a clear strategy helps manage the risk of losses associated with market volatility.

A structured approach makes it possible to remain aligned with the original investment strategy and continue pursuing specific objectives, while also helping to limit impulsive or emotionally driven decisions.

What do you need to know to rebalance a portfolio?

In order to rebalance a portfolio independently, without the support of a professional advisor, certain basic competencies are required

• to understand how markets work and the role of stocks and bonds, while monitoring the risk profile and investment time horizon
• keeping costs under control, such as transaction fees and taxes applied to gains
• having access to efficient monitoring tools and being able to read periodic reports

For these reasons, it is advisable to ask professional support in managing investments, working with advisers who can accurately define a client’s risk profile, build a diversified portfolio and apply a consistent strategy.

You should proceed independently only if you are experienced in the financial field and if you have a complete understanding of the dynamics of the markets in which you invest. If you are not an expert, you can instead rely on a bank or an online broker, which can provide specific advice and guidance.

A practical example of rebalancing

Let us consider a practical example of potential rebalancing, based on a strategy that monitors changes in the percentage allocation of invested assets.

Initially, the portfolio is worth £10,000, with 60% invested in equities and 40% in bonds. This means

• £6,000 in equities
• £4,000 in bonds

At a certain point, equities increase by 20%, while bonds remain unchanged. The total portfolio grows to over £10,000, so it is more exposed to risk.

To return to the target allocation, rebalancing is required by selling a part of equities and buying a part of bonds. In this way, the original percentage balance is restored.

This is just one example of how to rebalance your investment portfolio, as there are several strategies you can implement, depending on your goals and other variables. There isn’t a strategy that is better than another or that should always be used.

Pros and Cons

The key advantage of this approach is the ability to maintain over time the level of risk chosen initially, ensuring alignment with predefined objectives. These strategies also significantly reduce emotionally driven decisions caused by market fluctuations, helping to limit potential financial losses.

This disciplined approach promotes structure and consistency in investment management. However, it also requires time for monitoring and analysis, and may result in higher costs in terms of transaction fees. Furthermore, solid investment knowledge is necessary in order to carry out rebalancing effectively.

Alternatively, investors may ask for professional advice. Moneyfarm offers years of experience that enable individuals to approach investing in a simple and structured way, with good long-term growth potential.

How much does rebalancing cost?

The cost of rebalancing depends on several factors

• trading platform fees
• currency fluctuations investing in international markets
• taxation on gains and transactions
• any additional management charges

Some platforms include rebalancing within their management fee, making the process simpler and more transparent. However, rebalancing too frequently may increase overall costs, so it is important to strike the right solution.

Knowing management costs before starting to invest is essential to avoid losing resources and to plan for the future. Today, choosing a reliable online broker is generally more cost-effective than a bank, which typically asks higher fees and offers fewer investment options.

Portfolio Rebalancing with Moneyfarm

With Moneyfarm, rebalancing is an integral part of the portfolio management process. You can have access to a service that provides diversified portfolios across sectors, geographic regions and other key market variables.

Portfolios are constructed according to your risk profile and investment time horizon, and are continuously monitored by our advisers and technology. You can invest in ETFs, bonds and other financial instruments with transparency and confidence.

At Moneyfarm[CH2] , each portfolio is built around clearly defined allocation targets, aligned with the individual investor’s risk profile. Rebalancing plays a central role in maintaining that alignment over time.

Rebalancing is an ongoing process, just as important as the initial investment decisions, ensuring that portfolios remain consistent with long-term objectives. When carried out with the appropriate expertise and discipline, rebalancing helps investors stay on track and move steadily towards their financial goals.

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