Three strategies to rebalance your portfolio and maximise the benefits of diversification

When you first set up your portfolio, you’ve already decided how much cash you give to put in. And, in what asset classes you want to invest in. But, over time, the make-up of your portfolio might change. This will require you to rebalance your portfolio.

This happens because certain asset classes will earn you higher returns, so they take up a bigger share of your portfolio.

Generally, it’s the riskier assets that dominate (as they make bigger returns), which means you lose your portfolio’s diversification.

For example, stocks in your portfolio over time might increase to a 90% allocation in your portfolio.

This isn’t a good thing with the current volatility in stocks on the JSE. The poor performance of listed companies (and its
higher allocation) could cause big losses in your portfolio as they’ll outweigh all your other investments.

You need to avoid this situation! And here’s how…

1. Create a fixed time-table to rebalance your portfolio

Make sure you schedule time yearly, quarterly or even monthly to rebalance your portfolio. This helps to maintain the discipline of routinely looking at how the shape of a portfolio has changed.

You see, if you rebalance your portfolio more frequently, you’ll stick more closely to your actual asset allocation. The good news is it won’t affect performance or volatility in a material way.

However the costs of rebalancing in terms of taxes, commissions, and time and labour can affect your overall returns quite dramatically.

But there are other ways…

2. Rebalance your portfolio the risk-averse way

Let’s say you only want to allocate 10% to bonds in your portfolio. And, you never want your bond investments to exceed the 10% – This is where threshold rebalancing comes into play. With this second strategy, you rebalance your portfolio when the weight of an asset exceeds your specific target.

This is a more proactive and risk-averse approach, because it acts quickly to stop a portfolio becoming too heavily weighted in individual stocks.

However, one thing to remember is a portfolio of volatile stocks, could lead to you over-trading.

3. Time-and-threshold – The best way to rebalance your portfolio and reduce costs

If you take into account both costs and returns, a great solution is time-and-threshold rebalancing. In other words, review your portfolio periodically and only rebalance the stocks that have moved beyond your pre-set thresholds.

The rule of thumb for investors is once a year with a 5% threshold. But you don’t have to follow this exact rule. Just ensure
you can keep costs down by rebalancing at times when you add more funds. For example, you can reinvest your dividends into whichever asset needs topping up.

This is a good way to get your portfolio’s weighting back within your threshold without paying extra costs. While allowing room for individual positions to grow before you clip their wings.

You see, the bottom line is at least yearly rebalancing is generally a good idea, provided you do it for the right reasons and only when your portfolio really needs it.