What does 'rebalancing' mean?

saveonarola

I thought that 'rebalancing' was a technical term, meaning to sell what's gone up and buy what's gone down (assuming you still want to hold it long-term), in order to return the different funds, assets or whatever to their original proportions of the overall portfolio. That makes sense to me.

But then I read on Incademy, which otherwise seems an excellent source of information (thanks dunstonh for the tip), that rebalancing means selling or getting rid of what's performing badly. I can't provide a link, because the Incademy website seems to be down, but I promise you that's what it says.

Does 'rebalancing', in fact, just mean buying and selling according to what you think will do well in the future? Or do some people take a more mechanical approach?

Aegis

Strictly speaking, rebalancing means buying and selling to bring a portfolio back into line with your ideal asset allocation. As such, if your asset allocation changes, this will result in selling some of what's done well and buying some of what hasn't.

However, your ideal asset allocation can easily change, which might mean you end up buying more of what's doing well and selling some of what hasn't.

Reaper

Actually I would say it is neither of those.

Let's say you decided you wanted to be invested:
50% in Emerging Markets
50% in the UK

After a year or two the Emerging Markets sector booms while the UK stagnates. Now in terms of value your portfolio might look like this:

75% in Emerging Markets
25% in the UK

Although they have done well to that point Emerging Markets are a volatile area and you might not be comfortable having so much of your investment in it. So you sell some and buy more UK to rebalance it.

Now you are back to a 50-50 split.

EDIT: Beaten to it by Aegis

saveonarola

Thanks Aegis, Reaper. It makes sense now. As a novice investor, I was hoping for a way to take the human element out of it, but that's impossible, of course, because even if you decide to do the rebalancing in a mechanical way, you still have to decide on the asset allocation. There's no way around that.

I suppose you could say - for argument's sake - that it's always good to diversify by region, sector and asset class, so you could reduce the judgement required in the asset allocation to a bare minimum. But I realise that diversifying doesn't mean having the same percentage in everything, and there are circumstances in which that might not be the best course of action anyway.

Xbigman

Reaper wrote: »

Actually I would say it is neither of those.

Let's say you decided you wanted to be invested:
50% in Emerging Markets
50% in the UK

After a year or two the Emerging Markets sector booms while the UK stagnates. Now in terms of value your portfolio might look like this:

75% in Emerging Markets
25% in the UK

Although they have done well to that point Emerging Markets are a volatile area and you might not be comfortable having so much of your investment in it. So you sell some and buy more UK to rebalance it.

Now you are back to a 50-50 split.

EDIT: Beaten to it by Aegis

I think thats a bad example. It looks like rebalancing means what the OP first posted, (I paraphrase) sell success and buy failure.

Can I give a different example;

Start with
50% Emerging markets
50% UK markets

EM booms and UK is a dog. New balance becomes
75% Emerging markets
25% UK markets

Having 75% in one class is definately unbalanced, but the UK markets might not increase in future just because they have held back so far. Its a judgement call. A rebalance might look like,
50% Emerging markets
25% UK markets
25% Property

You might even split it further and go for four 25%'s

I think thats clearer.


X

Aegis

Xbigman wrote: »

I think thats a bad example. It looks like rebalancing means what the OP first posted, (I paraphrase) sell success and buy failure.

Can I give a different example;

Start with
50% Emerging markets
50% UK markets

EM booms and UK is a dog. New balance becomes
75% Emerging markets
25% UK markets

Having 75% in one class is definately unbalanced, but the UK markets might not increase in future just because they have held back so far. Its a judgement call. A rebalance might look like,
50% Emerging markets
25% UK markets
25% Property

You might even split it further and go for four 25%'s

I think thats clearer.


X

That example would be two separate stages in the way I've (badly, in retrospect) described it above: an adjustment to the ideal asset allocation followed by a rebalance of the portfolio to that new ideal asset allocation.

StevieJ

I thought that 'rebalancing' was a technical term, meaning to sell what's gone up and buy what's gone down (assuming you still want to hold it long-term), in order to return the different funds, assets or whatever to their original proportions of the overall portfolio. That makes sense to me

Correct

Reaper

Xbigman wrote: »

I think thats a bad example. It looks like rebalancing means what the OP first posted, (I paraphrase) sell success and buy failure.

Yes I misread their first point, that is indeed what it is about and is what my illustration showed. However I don't think your example is clearer and adds something different.

To me rebalancing is purely what I described. Wheras your example mixes in revising the portfolio. Revising and rebalancing may be done at the same or different times. One resets you back to your original strategy while the other is a change in strategy.

Xbigman

One resets you back to your original strategy while the other is a change in strategy.

Isn't rebalancing essentially a change in strategy too?

I'm begining to think this isn't quite the simple question it appears.

Another take on this, looking at the 50/50 moving to 75/25 example, is just how that change was achieved. If you get the 75% because that side shot up then its a rebalance based on success. If its because the 25% side tanked its a rebalance based on failure. In both cases you can call it a rebalance but the two processes are very different surely?



X

dunstonh

Another take on this, looking at the 50/50 moving to 75/25 example, is just how that change was achieved. If you get the 75% because that side shot up then its a rebalance based on success. If its because the 25% side tanked its a rebalance based on failure. In both cases you can call it a rebalance but the two processes are very different surely?

It may look like that with just two investments but typically, it would be across many more. Some will have gone up, some down, some stable but they will all be out of sync.

Also, a short term loss does not indicate failure. If it has gone down but not as much as the benchmark it is following then it has not failed. What has gone down in this period could be the one that goes up the most in the next.

You can get static rebalancing where you use the same ratios all the time or you can get fluid rebalancing where the allocation ratios change and you rebalance to those those revised ratios.

dtsazza

Xbigman wrote: »

Isn't rebalancing essentially a change in strategy too?

No, not really - certainly not in the case given.

The initial strategy was to hold 50/50 UK and Emerging Markets.

Due to the difference in relative performances, the proportion of the portfolio in these sectors has drifted. If you rebalance by bringing it back to 50/50, that's not a change in strategy - that's sticking with your initial strategy/allocation.