All the investment legends have in common the rebalance of their portfolio. Understanding rebalancing will help you to survive and create stronger performances.
If you actively trade, your percentage allocation of assets/cash constantly changes as you go in/out frequently. Portfolio rebalancing is a practice linked to a buy-and-hold approach, something more focused on the long term.
Let us suppose that you hold four assets in your portfolios:
Your goal should be to carry on your portfolio with the same asset allocation over time.
But even without dynamic changes to your portfolio, its structure will drift over time. This is correlated to the market movements of the single portfolio positions, causing a misalignment of asset percentages.
If this happens, it is time for rebalancing.
Positions with substantial gains should proportionally be sold, and positions that have lost value should proportionally be bought. This will bring your portfolio back to your original asset allocation. But let's make an example with the mentioned portfolio example.
Your ETH and BNB bags start to moon hard, and in 7 days, they will constitute not the original 25% but instead 32%. As said, the target is 25%.
What Then?
Cutting the profits and moving them to $BTC and $ATOM positions until the 25% is restored.
But you could be asking how often you should rebalance. Well, it depends on seasonality. You do not frequently rebalance during a bear market as prices are primarily flat/go down. During a bull market, when everything goes parabolic, you should rebalance more regularly.
Tips and Recommendations
Why Rebalance?
Portfolio rebalancing tends to provide buy and sell signals. This means you most likely will reduce positions in risky assets (small caps) in strong bull markets and increase them again in a bear market.
Have a Strong Discipline
Due to rebalancing, portfolio switches help you avoid timing the market approach by setting up a "forced" strategy. The important is to have an iron discipline to respect the rebalancing. Stick to the plan.
Do not Rebalance too Often
I know the crypto market is very volatile and might be tempting to rebalance daily/often. But if you start an exaggerated rebalancing, you'll burn money on fees/exchanges.
You can use two strategies:
Time- Rebalance your portfolio on a predetermined schedule, such as monthly or quarterly.
Fixed Threshold- Rebalance your portfolio only when its asset allocation has drifted from its target by a predetermined percentage.
Final Thoughts
Rebalancing is a key practice if you want to mitigate and control the risks + potentially increase the profits. I often see people forgetting about proper management of asset allocation, resulting in bad performance.
Apart from not cutting the winners and losing profits, the most common mistake is not adapting the asset allocation and continuing to ride risky plays with most of the portfolio.
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