When you have substantial finances, it is more than likely that, over a period, the rapport between all of them may get perturbed a little. This may happen because of many reasons, the major one of which is that people tend to pay more attention to one or more and lose track of others hence creating a severe imbalance between all the assets. This is where portfolio re-balancing comes into the picture. Portfolio re-balancing entails the process wherein various assets belonging to different classes are brought under major and minute changes (depending on the requirement) so that there can be established a healthy balance between all the assets.
How Does the Process Work?
So to speak simply, this is the process that re-establishes a perfect mixture of bond, cash and stock for you. This is a process that helps you get things into order after everything has been going against for far too long.
Let’s take up an example to understand the Nitti gritty of the process better. Suppose after you have determined everything as tolerance for risk, economic goals and Time horizon you come to the conclusion that your respective portfolio will have the following layout:
• Stocks: 60% = $60,000
• Bonds: 35%= $35,000
• Cash: 5%= $5,000
This will make a total of 100% and will translate into $100,000
Now due to some reason your stocks experience a hike and the outlook of this assessment changes and look somewhat like this:
• Stocks: 66%= $80,000
• Bonds: 29%= $35,000
• Cash: 4%= $5,000
This will make the total of 100% which now will translate into $120,000.
Now most of you would say that there is no visible problem in this at all since the total just hiked from $100,000 to $120,000, which is a straight profit of $20,000 and profit of any sort is good news or is it? Not quite so in this case, meaning it is good that the profit happened but this has also led the investor far from the acceptable allocation of assets and hence has made their position more risk prone than what can be handled. Now this is the point where any traditional investor will resort to portfolio re-balancing and will bring the whole allocation back to the original layout.
Some Practical Ways to Re-balance
Now the real question is about how you can change this imbalance into a restored original format. A very basic way to do it going by the above example would be to sell some of the stocks that have hiked and then invest that profit into the other assets, do this until you get back to the original proportion that was there. You can also teach your kids to invest in a right way.
Now you may not be too willing to sell the profitable stocks so you can just dig a little and find the ones that have been under performing lately. Sell those stocks and whatever money you get from that investment it into bonds and cash and get the original proportion restored.
As for another option, you can also invest some money that you have saved into cash and bonds to get a more balanced ratio between the assets. It will always seem more inviting to leave the assets the way they are but when you allocate them properly you lower down the risk at large while getting most suitable returns. Now if you do not do that you are just increasing the risk for yourself.
Moreover, while we are talking of portfolio re-balancing, let’s get this clear that it is just not re-establishing the balance of investment between the portfolios it can also entail creating a balance within a singular portfolio. There will several categories within stocks that will need to balance with respect to each other.