Should You Rebalance Your Portfolio?
Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Rebalancing a portfolio is the action of bringing a portfolio that has deviated away from one's target asset allocation back into line. Underweighted securities can be purchased with newly saved money; alternatively, over-weighted securities can be sold to purchase under-weighted securities.
Time is a slippery concept. It is constantly moving and changing your portfolio without detection. As the markets ebb and flow, the mix of investments that you originally put into place will probably change shape over time. If you let your portfolio run free, your long-term plan can be thrown off kilter. If left unadjusted, your portfolio will either become too risky, or too conservative.
Different research articles have been conducted on the topic of portfolio rebalancing. One of them highlights the improved return that the investor who rebalanced his portfolio enjoyed, in comparison to an investor who did not rebalance.
Put differently, the ultimate goal of any investor is to deploy his or her capital efficiently. The act of rebalancing assures that at any given point in time, your portfolio will be finely tuned to accommodate your level of risk tolerance and your expectations from the market.
Year-end is always a time of reflection, a rare opportunity where the usual psychological boundaries of time crumble. For a couple weeks, the tyranny of the present yields to a heightened consideration of the past and the future. This rift in our everyday thought patterns leads many investors to ponder the composition of their portfolios. This makes year-end a perfect time for portfolio rebalancing, both for individual investors and for mutual and hedge funds, alike.
A real-time example
I will demonstrate the concept of rebalancing by using a real -time example of Apple.
Shares of Apple (NASDAQ: AAPL) are now sitting at $560, after passing the $700 level just a few months ago. This plummet affected the whole market. After all, Apple constitutes almost 5% of the SPDR S&P 500 (NYSEMKT: SPY)! That is an disproportional amount of capital invested in a single company, compared to all other companies in the universe. At one point, it seemed that pretty much everyone in the world, except for me, owned shares of Apple. Once you add that to the fact the shares of Apple have skyrocketed by 75% from January through October, you get yourself a great example of how rebalancing is done in real life. The price appreciation caused many funds to be more equity biased than previously expected. And even those funds who did not mind this bias, could certainly not accept a situation in which Apple constitutes such a large part of their holdings, thereby exposing their performance to higher volatility and abrupt changes.
How can we profit from it?
As I mentioned above, mutual funds as well as hedge funds consistently rebalance their portfolios at each year end, just like they did with Apple. They are almost forced to. By following their activities in a vast array of stocks, an individual investor has a good chance to buy shares on a dip, once they "suddenly" go on a fire sale. In our case, an investor who had Apple on his watchlist but waited patiently for the right price - got himself Apple for a 20% discount.
The Fool's conclusion
It pays well to watch rebalancing towards year-end. Do your homework, review the stocks on your watchlist, and be prepared to buy on dips. It could be very profitable.
shmulikarpf has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!