Rebalancing can lock-in profits, trim losses

In Financial competency on 07/01/2011 at 5:21 am

What is rebalancing?

Rebalancing a portfolio involves setting a fixed portfolio allocation before you even invest. So, for example, if you have a fund dedicated to S’pore equities and S$ deposits, you first need to fix your allocations. Say you are an aggressive investor and allocate 95% of yr portfolio into S’pore equities by buying an STI ETF, and 5% into money market fund and S$ deposits.

Then, at the end of a fixed period (say every six or 12 mtrhs: you must choose a time frame and stick to it), you buy or sell the STI ETF until you have the 95%/ 5% allocation again: i.e you rebalance. And you must  do this consistently.

Alternatively you can rebalance whenever the STI ETF moves a certain %age  say 20%  (you must choose a %age and stick to it).  Say the STI ETF falls to 20% (yr predetermined level), you use yr cash deposits to buy more ETF shares to maintain the 95/5 balance: this is rebalancing. If it goes up 20%, you sell the 20% increase, and put the money on deposit.

Another example. You have an equity portfolio using ETFs that is aligned with the MSCI World Indices. This means 42% is invested in a US ETF, 45% in an ETF of other developed countries, and 15% in developing markets. Periodically you buy or sell to retain this original balance. Or alternatively you can rebalance when the proportions move out line by a certain %age

Why do it?

What rebalancing forces you to do is to take profit from your best performing investments, and invest more into the underperforming ones. This is a mechanical, non-discretionary method that works on the principle (or observation?) that markets, sectors and asset classes are cyclical: that nothing  will ever be the best performer all the time,  and neither will any market or asset class be a dog all the time.  Bit like the wheel of reincarnation or the saying, “This too will pass”.

The expectation (hope?) is that “the method will eventually result in you buying more of a market when that market is low, and selling some of the market that has gone up sharply. Thus, it ultimately results in an investor buying low and selling high, which is the recipe for a successful portfolio,” Fundsupermarket GM in a BT article.

And yes, the fixing of time periods or%ages can be arbitrary but at least they give you some fixed points of reference.


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