Rebalancing

Rebalancing is a financial management strategy used in the context of investment portfolios, primarily to maintain the original asset allocation and risk profile of a portfolio. This process involves periodically adjusting the weightings of various assets in a portfolio to ensure they remain consistent with the investor's desired risk tolerance and long-term financial goals.

Purpose and Role: The purpose of rebalancing is to maintain the desired asset allocation and risk exposure in an investment portfolio as market conditions change over time. The role of rebalancing is to ensure that the investor's portfolio does not become overly concentrated in any one asset class, which may expose them to higher levels of risk than they initially intended.

Components:

1. Asset allocation: Rebalancing is based on the concept of asset allocation, which involves dividing an investment portfolio among different asset classes (e.g., stocks, bonds, and cash) to balance risk and potential returns.
2. Periodic review: Investors should periodically review their portfolio to assess whether the current allocation still aligns with their financial goals and risk tolerance.
3. Adjustment: If the portfolio's allocation has drifted from the target allocation, investors can rebalance by selling assets that have increased in value and using the proceeds to buy assets that have decreased in value.

Importance: Rebalancing is important because it helps investors maintain a consistent level of risk in their portfolios over time. By periodically adjusting asset allocations, investors can reduce the potential impact of market volatility on their portfolio and enhance the likelihood of achieving their long-term financial goals.

Benefits, Pros, and Cons:

Benefits:

1. Risk management: Rebalancing helps maintain the desired risk profile of an investment portfolio by preventing it from becoming overly concentrated in a particular asset class.
2. Discipline: Rebalancing enforces a disciplined approach to investing, promoting a long-term focus and discouraging emotional decision-making based on short-term market fluctuations.

Pros:

1. Helps maintain the desired level of risk in a portfolio.
2. Encourages disciplined, long-term investing.
3. Potentially improves portfolio performance by systematically buying low and selling high.

Cons:

1. Rebalancing may trigger transaction costs, such as commissions and taxes, which can reduce the overall return on investment.
2. Rebalancing too frequently can result in excessive trading costs and may not provide significant benefits.
3. The optimal rebalancing strategy depends on individual circumstances and market conditions, making it challenging to determine the ideal frequency and approach.

Examples: Suppose an investor has a target asset allocation of 60% stocks and 40% bonds in their investment portfolio. Over time, the stock market performs exceptionally well, increasing the stock allocation to 70%. To maintain the desired asset allocation, the investor would sell some of the stocks and use the proceeds to purchase bonds, bringing the portfolio back to the original 60/40 allocation. This process of adjusting the portfolio's composition is known as rebalancing.

See Also

• IT Strategy (Information Technology Strategy)
• IT Governance
• Enterprise Architecture
• Chief Information Officer (CIO)
• IT Sourcing (Information Technology Sourcing)
• IT Operations (Information Technology Operations)
• E-Strategy

Popular Articles

• Personnel Management
• Architecture Development Method (ADM)
• IT Operating Model
• Strategic Intent
• Data Governance
• Business Capability
• IT Strategic Plan (Information Technology Strategic Plan)
• IT Ecosystem
• Information Technology (IT)
• International Accounting Standards Board (IASB)
• Economic Value Added (EVA)
• Strategic Business Unit
• Business Process Architecture
• Configuration Item (CI)
• IT Operations Management (ITOM)
• Organizational Goals
• Business Process Engineering (BPE)