Portfolio rebalancing is crucial to any asset allocation project in which an investor chooses to minimize the risks taken while maintaining a certain percentage of funds in various sectors of the economy. The funds available include cash, stocks, bonds, and many other types of investment opportunities available to investors who choose to deal in the stock market.
The key to the concept of portfolio rebalancing is the elimination of risk in order to strengthen a healthy portfolio that will continue generating profits over time. For example, if 50% of a portfolio is invested in stocks, and the other 50% in bonds, the investor must ensure that this ratio does not suffer over time. Allowing percentages to exceed their proper proportions will cause the investor to develop a high level of risk in a certain asset.
By adhering to the principles of portfolio rebalancing, the investor could take many actions to restore the balance among his assets. He could remove funds from one portion of his portfolio and transfer the profits to another area. In the previously mentioned example, if the portfolio shifts from 50% stocks and 50% bonds to 70% stocks and 30% bonds because of some increase in the stock value, it would be possible to sell 20% of the stocks that earned a higher amount and use the profits to invest in bonds until the portfolio is stabilized. Additionally, the investor could sell the underperforming stocks and use the funds in other assets that he or she owns, thereby reducing the risk and increasing the profitability at once.
Portfolio rebalancing is a necessity to developing and maintaining a proper level of risk that is acceptable and will not leave the investor vulnerable to gross reductions in his or her assets. By allocating assets with this method, it is possible to profitably manage several funds at once even if they are completely unrelated.