From time to time, the stock market may experience high levels of trading and larger than usual price fluctuations in the broad market. These dramatic price movements often result in deviations from our intended asset allocation, causing a change in our portfolio that is not in line with our risk profile. One of the most important duties of portfolio managers is to achieve clients’ investment objectives in accordance with their risk profile and this often necessitates rebalancing.
Rebalancing is principally a risk management exercise that rearranges clients’ portfolios to be in line with their investment goals. It works by changing the weightage of investments back to the targeted strategic asset allocation via a series of transactions. In the case of KDI Invest, the weightage of our primary investment vehicle, Exchange-Traded Funds (ETFs), will be adjusted back to the weightage as determined by our algorithms.
Importance of Rebalancing
Although the famous investment adage of letting your winners run high holds true, such deviations may cause a mismatch in the investors’ risk profile. If this is left uncontrolled over a long period of time, resulting in an allocation drift, any market turbulence could lead to undesirable losses.
To better illustrate our point, let us consider two portfolios with a mixture of stocks and bonds where one is rebalanced, and the other remains untouched for the same amount of time.