The importance of rebalancing your investment portfolio

 Key takeaways:‍

• As market conditions change, the weight of different assets in a portfolio will drift from the original target allocation. Portfolio rebalancing is the process of realigning this weight to match the investor's risk tolerance and investment goals.
• There are various methods to rebalance a portfolio, including periodic rebalancing (at a set period) and threshold rebalancing (when the portfolio drifts more than a certain percentage from the target allocation). 
• Switching costs pose a challenge to implementing an effective rebalancing strategy. At Endowus, we do not charge fees for switching.  We offer automatic portfolio rebalancing to ensure your investments stay on track. This means keeping the target mix of assets such as stocks and bonds in line with how you want it (for example, 60% stocks and 40% bonds). 
• You also have the option to be a "do it yourself" investor and maintain the discipline of rebalancing in your investment plan, all without sacrificing the returns you deserve.

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"Better learn balance. Balance is key. Balance good, karate good. Everything good. Balance bad, better pack up, go home. Understand?"

• Mr. Miyagi, The Karate Kid

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As I toppled over (yet again) in a one-legged tree pose, my yoga teacher shared a secret on finding balance: it's not static. It's the constant shifting of weight from side to side, falling in and out, and then moving back to find your centre. It also requires mental discipline, as you focus on a drishti, a means for developing concentrated intention. 

Your investment portfolio is no different–your asset allocation does not remain static as the market moves. Your portfolio weights will constantly fall in and out of balance and drift from your target allocation, and it is key to take a disciplined approach to rebalance your portfolio.

What is portfolio rebalancing?

Determining the right mix of investments in a portfolio is arguably the most important decision you can make. If you had originally built a balanced portfolio a year ago comprised of 60% equity and 40% fixed income, it's likely that the recent strong equity markets would have now led to a higher equity allocation in a portfolio. 

Take a higher than initially planned equity exposure as an example. Because of that, the volatility of your portfolio is now also higher than your target allocation, which may be higher than what you can cope with emotionally if the markets turn. 

Whilst we may like to think that we are rational beings, when it comes to our money, the science is not in our favour. There are multiple benefits a discipline of rebalancing can bring about. 

First, rebalancing your portfolio back to the asset allocation in line with your risk tolerance, and therefore in line with your emotions, will help you stick to your investment plan over the long term. Rebalancing can be difficult because it often involves selling winning assets that are outperforming the market to buy ones that are underperforming. As painful as it may be, it works. Over the long run, rebalancing boosts returns and decreases portfolio volatility significantly.

Second, rebalancing can help maintain a diversified investment portfolio, reduce the risks caused by excessive concentration in a single asset or market, and improve the overall stability of the portfolio.

Third, the discipline steers us away from emotional decision-making. The rebalancing strategy encourages investors to adjust positions according to pre-set plans rather than market sentiment to avoid irrational buying and selling behaviour due to short-term market fluctuations.

How do you rebalance your portfolio?

For DIY investors, who construct and manage their own investment portfolios, there are two ways to implement the rebalancing mechanism.

Common rules include quarterly or annual rebalancing (commonly known as periodic rebalancing, or rebalancing when your portfolio drifts greater than a certain percentage from your target allocation (threshold rebalancing). 

Both have their pros and cons. While periodic rebalancing is more straightforward, it can lead to frequent and relatively minor changes. As for threshold rebalancing, it is flexible, yet it can trigger a lot of dubious buying and selling in volatile markets.

Choosing an investment platform that does not impose switching costs on mutual funds can significantly facilitate regular rebalancing of an investment portfolio. 

Without the burden of switching costs, investors are free to reallocate their assets among different mutual funds to maintain their desired level of risk and return. Regular rebalancing allows investors to lock in gains, limit losses, and stay aligned with their investment goals. 

How Endowus rebalances your portfolio

Endowus leverages its technology to rebalance portfolios dynamically and minimises cost by using every cash flow (either investment or redemption) to constantly bring your portfolio back to "balance". The auto-rebalancing feature is one of our value-added, embedded services for clients.

When the allocation of a fund is out of alignment with its target asset allocation by 15% due to market fluctuations, our automatic rebalancing function will be activated. For example, if a fund within a portfolio has a target allocation of 10% and, over time, this fund’s allocation moves by +/- 1.5%, the auto-rebalancing process will start. Following the activation of auto-rebalancing, you will receive an email notification stating that Endowus will be executing a rebalance for your portfolio after 24 hours unless you opt-out.

During the rebalancing procedure, we will first redeem units in the funds overweight their target allocation. Once the redemption is done, we'll use the proceeds to invest in those that fall short of their target allocation. This approach aims to align the portfolio as closely as possible with its intended asset allocation. The auto-rebalancing process takes up to 7 business days to finish.

Portfolio rebalancing takes the emotions out of investing

The greatest gift investors can give themselves is to take their emotions out of investing. 

Along with dollar-cost averaging, portfolio rebalancing helps investors stay disciplined. It may be difficult to trim the assets that have been doing well, but if you think about it–you're actually selling high and buying low through portfolio rebalancing.

To help stick with your investment discipline, Endowus offers unit trusts at zero switching costs, and the access to lower-cost institutional share class funds, not normally available to retail investors at other distributors also lowers your investing expense over time. That’s how you can keep more returns on your investment. Check out the Endowus investment fund list in the comfort of your home. 

Another way is to invest in Flagship Portfolios, which come with a pre-set asset allocation across stocks and bonds. You can choose to invest in our Flagship solutions using cash, Supplementary Retirement Scheme (SRS), and/or CPF.