When to Rebalance your Portfolio

 

“When to rebalance my portfolio?” or “Should I even rebalance my portfolio at all?” are some of the most commonly asked questions in the Trading212 Pie community.

Trading212 doesn’t really do a great job of explaining what rebalancing is or when to rebalance but does a great job of putting a huge button on your screen that says rebalance in all caps, so it’s not really surprising that there is so much mystery and confusion about it.

Trading212 Rebalance Button

 

So I decided to write a post and make a video to try to answer the common question of when to rebalance your portfolio.

 

 

So today we are going to cover:

 

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  • What is Rebalancing?
  • Why Would you Rebalance?
  • How Often Should you Rebalance
  • The Optimal Time When to Rebalance
  • How to Rebalance

 

What is Rebalancing?

 

The process of realigning the weightings of a portfolio of assets is known as rebalancing.

 

Rebalancing is purchasing and selling assets in a portfolio on a regular basis in order to preserve an original or intended level of asset allocation or risk.

 

For example, the typical, slightly dated nowadays, conservative portfolio would be something like 60% stocks and 40% bonds.

60% Stocks 40% Bonds

This is conservative because stocks tend to be riskier so the person building this portfolio is likely to not want to take too much risk and so has a high proportion of bonds in that portfolio too.

Over time the stocks are likely to grow at a faster rate than the bonds if it is a bull market for stocks. This means that the portfolio will go from 60% stocks and 40% bonds to closer to 75% stocks and 25% bonds.

A portfolio that needs rebalancing

 

Now the investor wanted 40% bonds, not 25% because they were concerned about the risk. So, although they didn’t actually do anything, their portfolio is now too risky for their own requirements.

 

Therefore, they need to balance the stocks and bonds back to their original allocation. This involves selling the stocks that are higher than before and then buying the bonds.

 

This is rebalancing.

 

As you can see rebalancing will inherently buy low and sell high – the mantra of every good investor.

 

If we use the example of the almost daily dividend portfolio, which many of you may already be using already, we can see what rebalancing entails if you invest in individual stocks.

 

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If you have had the almost daily dividend for any length of time you will see that each stock has its own direction and some grow at very different rates from others.

 

This means that if you don’t keep the portfolio balanced they will all be at very different values after some time.

 

So Why Would You Rebalance?

 

As already mentioned, rebalancing will inherently buy low and sell high. If your portfolio has some big winners and some losers, you will lock in the profit of the winners and take advantage of the fall in the price of the losers.

 

This only makes sense if you still believe in all the stocks that you are holding.

 

In the case of the almost daily dividends portfolio, if you rebalance you are potentially getting a better yield by rebalancing.

 

As the relationship between price and yield percentage is inverse or as one goes up the other one goes down, selling stocks that have risen up and using the money to buy underperformers should increase the overall yield.

 

Of course, this completely depends on the actual stocks being bought but, in theory, you are increasing the amount you will be getting back from dividend payments.

 

How Often Should You Rebalance?

 

This is a good question. Now you know the benefits of rebalancing, why not just do it all the time? You would be locking in profits and taking advantage of every market dip right?

 

Well, the first thing to consider is that even with zero fee trades you would be facing some loss of portfolio value with attrition every time you rebalance.

 

This is due to spread on the platform you choose. Spread is just the difference between the immediate buy price and the immediate sell price. For some stocks, this difference will be wider than for others.

 

The second point is that rebalancing too frequently doesn’t actually improve your returns by any measurable amount.

A study was done on the following rebalancing time periods: monthly, quarterly, semi-annually, annually, and never.

You can read the link to see the full details but I will summarise them here.

 

The backtesting simply assumed $100,000 was invested in January 1979, with no further contribution or withdrawal since, and with no leverage applied.

 

The results of the study on when to rebalance showed no functional difference between monthly, quarterly, semi-annually, and annually.

 

However, when ‘never’ was compared with the other time periods it significantly underperformed.

 

If assets are indeed held long enough, the relative weightings of each will become skewed, which will also in turn skew the risks in the portfolio unfavourably. The asset mix will no longer be relatively balanced. This means more reliance on a certain type of environment for the portfolio as a whole to do well.

 

For instance, if stocks do well over time and become a greater weighted proportion of the portfolio, the portfolio will become increasingly reliant on a higher growth, and higher inflation environment.

 

So to answer how often should you rebalance a portfolio, the answer is that it depends but once a year is fine realistically.

 

When to Rebalance your Portfolio?

 

So we know that once per year rebalancing is fine but is there an optimum time of year to rebalance?

 

Actually, whilst deciding when to rebalance, the benefit (or negative impact)is pretty much based on luck. Corey Hoffstein’s study found that for reasonably concentrated portfolios (100 stocks) with semi-annual rebalance frequencies (which is common in many index definitions), annual timing luck ranged from 1-to-4%.

If you are using the pie feature on Trading212 you can use your initiative when you look at the pie holdings section.

If your pie looks like this it is probably fine, the allocations haven’t slipped too far and it’s still in order.

Trading212 portfolio no need to rebalance

 

If your pie is starting to look more like this then it could be well worth rebalancing as that is now pretty far from your intended allocations

This shows when to rebalance

So deciding when to rebalance can be too hard to set for non-technical guys like us so it’s better to just set a certain date and do it on that date each year.

This regular scheduling method is a better system than asking yourself when to rebalance each time.

 

How to Rebalance your Portfolio

 

If you are using the Trading212 pie feature then it is pretty easy, it will rebalance automatically for you as long as the market is open. All you need to do is click that button I mentioned earlier.

 

If you use another broker it’s a little harder, especially if you are buying individual stocks.

 

You will have to calculate your ideal weighting based on the amount of money you have in your portfolio and then buy and sell them all yourself which is obviously a bit more time-consuming.

 

A tool like Sharesight will help you calculate your portfolio weightings but you will have to do the buying and selling yourself, unfortunately. For those of us in the UK and Europe, I think Trading212 for individual stocks and InvestEngine for ETFs are probably the best for rebalancing and building your portfolios in the first place if you want them to be in a certain % allocation.

Neither of these will update you on when to rebalance exactly… but will give some major clues on whether its time to rebalance or how far away you are from your desired allocation.

 

How do you decide when to rebalance? What are your tips on rebalancing? Share them below!

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