Experienced investors understand the importance of investing for the long-term. Making frequent tweaks to a portfolio or aiming to time the market is usually counterproductive.

Most investors are familiar with the concept of ‘buy and hold.’ This means keeping an investment for a long period of time. Short-term volatility is less of a concern as the goal is to benefit from increased value over time.

But a long-term investment strategy doesn’t simply mean doing nothing. It’s important to monitor your portfolio to ensure it still matches your risk profile and meets your requirements. 

Rebalancing is one way in which you can ensure your investment plans remain on track.

The Assets in Your Portfolio
Typically, a portfolio might hold the following assets:

• Equities, or company shares
• Property funds
• Bonds, or fixed-interest securities
• Cash

These assets vary in terms of risk and reward profile. 

Equities offer the highest growth potential but are also more likely to fluctuate and even lose money in the short term. 

Cash is the most stable asset, but the value is unlikely to keep up with inflation. 

Property and bonds fall somewhere in between.

There is also variation within each asset class. Equities can encompass shares from large global companies or emerging smaller companies. Some shares carry more risk than others.

A good investment strategy aims to invest as widely as possible, as this means that your portfolio is not invested too heavily in any one area. This is known as diversification.

Portfolio Drift
When you build your portfolio, you will have a certain percentage in ‘growth’ assets, such as equities and property, with the remainder in ‘defensive’ assets, such as cash or bonds. 

Within this, you would hold a proportion in different sectors, for example, Japanese equities or global corporate bonds. 

The most suitable asset allocation will depend on how much risk you can or wish to take with your investments.

But even after a few months, the percentages will be skewed. Equities are more volatile than bonds and will fluctuate more rapidly.

This means that when the market goes up, equities will form a higher percentage of your portfolio, leaving you more exposed when prices eventually drop.

If the market goes down, the proportion of equities falls, which means that you will benefit less from the subsequent recovery. 

What is Rebalancing?
Rebalancing aims to bring the portfolio back into line with the recommended percentages.

This is sometimes an automated process, meaning that the proportions are automatically realigned with a defined template at set intervals.
Another option is to rebalance when any of the fund percentages are out of line by a certain amount, for example, 10% or 20%. 

Some investment managers operate tactical rebalancing, which means that they make an active judgement over when and how to rebalance. 

Rebalancing can also occur alongside model portfolio management. For example, investment managers might continually review the investments and the proportions held within a given model. Changes can be made at any time.

Rebalancing is a separate part of the process that aims to align investors’ money with the most up-to-date version of the model at the agreed frequency.

If you invest in a multi-asset fund, rebalancing will be done behind the scenes without your involvement.

Why is Rebalancing Important?
Rebalancing is important because it keeps your portfolio within a consistent risk level. This has the following benefits:

• It avoids becoming too exposed to equities when the market rises, as ‘excess’ equity content will be sold to top up the proportion held in other assets. This stops the volatility level from rising and ‘locks in’ the growth that has been achieved.
• It also means that when equity values fall, you take advantage of the drop in prices to buy more shares. When the market rises again, this can help to boost your returns.
• It prevents your portfolio from becoming too concentrated in any one area. For example, throughout 2024, technology, AI, and healthcare companies saw significant growth. Without rebalancing, your portfolio would be over-exposed to these areas, and less well-placed to benefit when the next investment trend arrives.
• Regular rebalancing also means that you don’t need to make judgement calls about when to buy and sell; you simply stick to pre-determined parameters. This strategy is just as likely (if not more so) to yield positive returns as active management, without the accompanying decision fatigue and buyer’s remorse when you make a mistake. 

When Should You Rebalance?
There is no universally agreed timetable for rebalancing. This may occur:

• Daily
• Monthly
• Quarterly
• Six-monthly
• Yearly

More frequent rebalancing means the portfolio is kept more stringently in line with the agreed asset allocation. It also means that the portfolio is more responsive to sudden market movements – if a fund drops in value, it immediately purchases more. 

However, rebalancing too often can also curb growth. High-performing investments are quickly brought back into line rather than being allowed to run their course. If a fund increases in value every day for six months, you will still benefit from 180 days of growth. But you will miss out on the compounding of that growth. Compound interest, or compound growth, is one of the most powerful principles in finance. 

Of course, rebalancing too infrequently can also cause problems. If higher risk funds are left to grow unchecked for too long, the portfolio is more at risk during a downturn.

While it is clear that rebalancing is a good idea, the frequency and method will depend on your investment strategy, risk tolerance, and objectives.