During the high ups and high downs in the market, investors always need to ensure that they are properly positioned. You should always be thinking a few steps ahead of the market changes you see today; this is where rebalancing comes into play. During times of volatility, portfolios can shift one way or another, causing changes to the risk profile and the target asset allocation. The target asset allocation is the balance of bonds to equities in an investment. As a result of the COVID-19 market changes, many investors are seeing their portfolios shift to a more conservative allocation
Rebalancing restores your target asset allocation
Rebalancing is the process of periodically comparing your original asset allocation to the current portfolio breakdown. If the holdings are outside of your threshold level, it may be time to rebalance your portfolio. When you rebalance you shift a portion of your portfolio from equities to bonds or vice versa. Think of this like loading a delivery truck, at the beginning each side has equal weight. However, if boxes are loaded faster on the left side, the truck becomes uneven. Moving some of the boxes from the left side to the right side will bring the truck back to balance. This is similar to what happens in your portfolio when the equities outperform bonds. This causes a greater proportion of equities in your portfolio than the target asset allocation. This now places the portfolio in a higher risk category and potentially increases the volatility of the investment.
Rebalancing during market volatility
The most ideal time to rebalance would be at the top and bottom of the markets, but knowing exactly where those are, only occurs after those events have already happened. During the current market downturn, portfolios likely have become more conservative, as equities saw a sharp sell-off. Being more conservative might be seen as a positive during these times, but it can also hinder your ability to quickly recover when the market rebounds. Rebalancing can be accomplished with the opportunity to invest new money in the market to increase your equity hold and effectively rebalance your portfolio at the same time.
Strategic changes to investments
Rebalancing is a natural opportunity to change up your asset allocation if you are not comfortable or confident in the current allocation. When life events happen, such as marriage, new job, or retirement is the other time asset allocations should be shifted to fit your needs. It is important to resist the urge to cut your losses and move your money to cash, as investing is long term and short term loses can be expected. Ensure you are reviewing your asset allocation with your advisor to ensure your portfolio is matching your risk.