Portfolio rebalancing is the process of realigning the weightings of a portfolio's assets to maintain a desired risk and return profile.
Portfolio rebalancing involves periodically buying or selling assets within an investment portfolio to restore the original or strategic asset allocation. Over time, market movements cause portfolio assets to drift away from their target allocations, increasing or decreasing risk exposure. Rebalancing ensures the portfolio remains aligned with the investor's objectives, risk tolerance, and investment strategy, often reflecting allocations among equities, fixed income, cash, and alternative investments.
Consistent portfolio rebalancing is critical for maintaining disciplined investment management and risk control. It helps prevent unintended overexposure to certain asset classes that may have outperformed and become overweight, which could lead to higher volatility or risk. For private wealth and family offices, rebalancing supports long-term wealth preservation and growth goals, while also aiding in tax planning by managing the timing and recognition of gains. Additionally, it supports governance by enforcing adherence to the agreed-upon investment policy.
Suppose a family office sets a target allocation of 60% equities and 40% bonds. After a year, equities have appreciated and now represent 70% of the portfolio while bonds have dropped to 30%. To rebalance, the family office sells some equities and buys bonds to return to the 60/40 target allocation, realigning risk exposure with the original investment strategy.
Portfolio Rebalancing vs Portfolio Optimization
While portfolio rebalancing focuses on maintaining or restoring a preset asset allocation by buying and selling assets, portfolio optimization involves using quantitative techniques to construct a portfolio that maximizes expected return for a given level of risk. Rebalancing is about discipline and adherence to a strategic plan, whereas optimization is about finding the most efficient portfolio based on risk-return trade-offs.
How often should portfolio rebalancing be performed?
The frequency of rebalancing depends on the investment policy and market volatility; common approaches include calendar-based intervals (e.g., quarterly or annually) or threshold-based triggers when asset weights deviate by a specific percentage from targets.
Does rebalancing trigger tax consequences?
Yes, selling assets to rebalance can realize capital gains, which may be taxable; tax-efficient strategies and timing are important considerations when rebalancing in taxable accounts.
Can rebalancing improve portfolio performance?
Rebalancing primarily manages risk and enforces discipline rather than directly enhancing returns. However, it can improve risk-adjusted performance over time by preventing overconcentration and locking in gains systematically.
