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PORTFOLIO REBALANCING
WHAT IS REBALANCING
Portfolio rebalancing is the process of bringing
the different asset classes back into proper
relationship following a significant change in
one or more.
 More simply stated, it is returning your portfolio
to the proper mix of stocks, bonds and cash
when they no longer conform to your plan,
when a drift occur.
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NEED FOR REBALANCING
Holding a portfolio or an asset that is
overpriced and hence inferior returns.
 Composition of a portfolio may no longer
reflect the investor’s objectives
 A poorly diversified portfolio, which is riskier
than what an investor can bear
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NEED FOR REBALANCING
Changes in the attitude of the investors toward
risk
 Changes of investment goals
 Liquidity needs of the investor
 Fluctuations in stock markets provide
opportunities for both positive and negative
aspects.
 Changes in Monetary policy, such as changes
in interest rates and inflation.
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REBALANCING CONSIDERATIONS
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Rebalance at least annually
Minimize transaction costs and tax consequences by adjusting
new money, not liquidating existing assets
Consider using lump-sum payments
PORTFOLIO REBALANCING
Rebalancing the portfolio involves:
 Either changing the securities currently
included in the portfolio
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Or altering the proportion of funds in the
securities
WHEN TO REBALANCE PORTFOLIO
Different Strategy to decide when to Rebalance:
 Periodic Rebalancing
 Threshold Rebalancing
 Range Rebalancing
 Volatility-Based Rebalancing
 Active Rebalancing
PERIODIC REBALANCING
Portfolios are reset to their target allocations on a
fixed schedule—such as annually, quarterly or
monthly.
 Assets that are overweight relative to the longterm targets are sold, and the funds used to
purchase underweighted assets, until the original
allocations have been restored.
 This strategy has the virtue of simplicity, but can
require frequent, minor adjustments.
 It is also rigid, and doesn’t allow investors to
temporarily overweight asset classes or sectors
that are expected to outperform over the shorter
term.

THRESHOLD REBALANCING.
Portfolios are adjusted if and when a particular
asset class deviates from its target allocation by
more than a certain amount—say plus or minus
five percentage points.
 So if, for example, the target for large-cap stocks
was 60%, but a market rise caused that share to
climb above 65%, stocks would be sold and other
asset classes purchased until the original 60%
target had been restored.
 This is obviously a more flexible rule than periodic
rebalancing, but in volatile markets it can trigger a
great deal of unnecessary buying and selling.

RANGE REBALANCING
This approach is similar to threshold rebalancing,
except that when an asset class rises or falls more
than the allowed amount, it is rebalanced back to
the maximum, not the target, allocation.
 Suppose, for example, a portfolio has a 20%
target for small-cap stocks, plus or minus five
percentage points, but a sudden market rise takes
that percentage to 28%.
 Stocks would be sold until the small-cap share had
been returned to 25%— not the initial 20%
allocation.
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VOLATILITY-BASED REBALANCING.
Triggers are based on the expected volatility of
the portfolio as a whole. When volatility rises
above a certain predetermined threshold,
higher-volatility asset classes are sold and
lower-volatility asset classes are purchased.
 So, for example, excessive volatility might lead
an investor to sell small-cap stocks— a relatively
risky asset class—and buy short-term bonds—a
relatively low-volatility asset class.
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ACTIVE REBALANCING.
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Portfolios are rebalanced to the original target
allocations as needed, based on analysis of expected
market conditions.
This approach is similar to “tactical” asset allocation,
which seeks to exploit short-term market trends.
Believe markets are not continuously efficient, and
securities mispricing at times gives an opportunity for
beating market.
Practitioners believe that they can beat the market.
Combines both fundamental and technical analysis
Higher transaction cost
FORMULA PLANS
Based on predetermined rules that specify the
nature, timing and proportion of change.
 Contains two portfolios: aggressive and
conservative. They differ in their volatility and
the type of investments.
 Economic conditions and the aggressive and
conservative portfolios.
 The prices of the two portfolios
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FORMULA PLANS
The volatility of the aggressive portfolio
depends on the risk tolerance of the investor.
 The aggressive portfolio can be divided among
a number of stocks with high volatilities to
overcome any pitfalls in the future expectations
of the stock movements.
 Formula plans provide the highest gains if the
stock prices move through a full cycle, a peak
and a trough.
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CONSTANT DOLLAR VALUE PALN
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Such as rebalancing when the aggressive
portfolio moves up or down by 20%
CONSTANT DOLLAR VALUE PALN
CONSTANT RATIO PLAN
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Such as when the amount invested in each
portfolio is equal, then revising the portfolio
when the ratio of the aggressive portfolio to the
conservative portfolio changes upward or
downward from the target value of 1 by 10%.
So the first action point will be either at 1.10 or
at 0.90. The adjustment is made so the two
portfolios should be equal.
CONSTANT RATIO PLAN
COST OF REBALANCING
The actual benefits of rebalancing—and the
correct choice of rebalancing strategies
depend on many factors, some of them unique
to each investor.
 Most individual and corporate investors, for
example, must pay taxes. Frequent rebalancing
could lead to the realization of substantial
capital gains, and the taxes on these gains
might offset any improvement in post-tax
returns.
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COST OF REBALANCING
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Brokerage commissions and other trading
costs also need to be taken into account.
PRACTICAL PROBLEMS IN PORTFOLIO REVISION
Risk bearing ability: investors may have
difficulty in expressing their risk-tolerances in
terms of portfolio volatility.
 Investment planning horizon: the Shorter the
time frame, the lower the probabilities of
achieving expected returns
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The Benefits of
Portfolio (video)
Rebalancing
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