The importance of rebalancing your investment portfolio

"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

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 center. It also requires mental discipline, as you focus on a drishti. 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.

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 that recently strong equity markets would have now led to a higher equity allocation. 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. 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 volatility significantly.

Read more: Rebalancing Effect (Morgan Stanley)

It helps to have rebalancing "rules" you commit to ahead of time.

Common rules include quarterly or annual rebalancing, or rebalancing when your portfolio drifts greater than X% from your target allocation. Endowus leverages its technology to rebalance portfolios dynamically and minimizes cost by using every cashflow (either investment or redemption), to constantly bring your portfolio back to "balance".

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