Updated: October 1, 2012
This post is the third part of the series on Personal Portfolio Management. Just in case you missed it, you can read the second part on Investment Diversification here.
After doing proper asset allocation and diversification, your next step in making sure that your investments are optimized to your needs is to rebalance your portfolio after a certain period.
Rebalancing simply means evaluating your investment objectives, and editing your assets portfolio to ensure that they are still in line with your financial goals and requirements.
This is a necessary task which you must regularly do as often as you believe necessary, but I suggest at least once a year.
Why do you need to rebalance your portfolio?
The foremost reason why you should do this is because investments don’t always perform as expected, some can experience stagnation, others can grow faster than usual, while some, end up performing poorly over time.
When that happens, your risk profile will change.
For example, let’s say you invested P20,000 in treasury bills (short-term low-risk); P50,000 in a balanced fund (medium-term moderate-risk); and P30,000 in the stock market (long-term high-risk). This means your total money of P100,000 has a risk profile of 20-50-30 (low-moderate-high).
After a year, the net value of your low-risk investments has grown to P21,000; meanwhile, your moderate-risk assets lost a little value and became P49,000; and lastly, your high-risk investments performed well and has grown to P40,000.
Your original portfolio has grown by 10% and is now worth P110,000. But if you calculate your risk profile, you’ll see that it’s now roughly 19-45-36.
If you want your original risk profile of 20-50-30, then you need to rebalance your portfolio by funneling some of your high-risk investments to lower-risk assets.
How To Rebalance Your Portfolio
Low-Risk Assets
If the percentage is less than what you want, then consider adding “new low-risk assets” to your portfolio. If it’s more than what you want, then sell some of it and invest in higher risk assets.
Moderate-Risk Assets
If the percentage is less than what you want, then consider adding “low-moderate risk assets” to your portfolio. If it’s more than what you want, then sell some of it and invest in lower or higher risk assets.
High-Risk Assets
If the percentage is less than what you want, then consider adding “moderate-high risk assets” to your portfolio. If it’s more than what you want, then sell some of it and invest in lower risk assets.
Shouldn’t I sell poorly performing assets?
Low-risk assets rarely lose value, they usually just become stagnant (value remains the same, or don’t earn as much). When this happens, you have the option to sell it and buy another type of low-risk asset.
When your moderate-risk assets lose value, it may be a good idea to monitor them more regularly and set a price which you would be willing to sell at a loss. My personal preference is 10%.
In our example, our moderate risk assets went down to P49,000 from P50,000. I shouldn’t worry much about that, but I have to monitor them closely. If their value goes down to P45,000 (losing 10% of its original value), then I would sell those assets to prevent me from possibly losing more.
Lastly, when high-risk investments lose value, then it’s also wise to monitor them more closely and again, set a price which you would sell at a loss. With this, I set it at 20%. High-risk investments tend to be volatile, that’s why I give them “more space” to move down.
Personal finance is personal
I’d like to remind everyone that these are just suggestions. You should always set your own “stop loss” percentages that is in accordance to your personal risk tolerance.
Adding more to your portfolio
If you need to add more assets in your portfolio, always go back and consider the advise I gave in diversification.
When rebalancing, try to sell off investments from over-weighted categories and funnel them to new or under-weighted categories. Also, as long as an investment is not losing money, then my advise is to just let it run its term and grow.
Lastly, always remember to invest regularly. If you have a big amount of money to invest, don’t do it in one go – instead invest in smaller, more frequent, portions so you can take advantage of cost averaging.
I hope you found my three part-series on personal portfolio management helpful. This is exactly how I manage my own finances and I hope you were able to pick up a few tips from it.
End of Part 3 and Series.
Series Guide:
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Disclaimer: The investing tips in this post is solely based on personal knowledge and experience. It does NOT constitute as professional financial advice. Consult with a certified adviser to address your specific financial concerns.
[…] How To Rebalance Your Portfolio: Personal Portfolio Management Part 3 […]
Hi Fritz,
Just an inquiry. Where should I classify my investment in AFPSLAI?
Thanks.
Hi Maribeth,
I’m not very familiar with AFPSLAI, but from what I’ve researched, I would consider your investment in AFPSLAI as low to moderate risk.
It’s more on the low-risk side actually because the company has been operating for many years now without any problems (am I correct?), and for the most part, acts as a “money market savings fund”.
I only learned this investing in UITF/ Mutual Funds just recently. i would have invested longtime ….
I have SSS Flexi fund and investing 10,000 monthly. Its earning I think around 1% per month compounded. I believe SSS invests this in 91day Treasury Bills, so I consider this as low risk. This money is also considered to be my Emergency Fund/savings as this is very liquid. Is that ok?
Now I learned the diversification and wants to invest to Balanced and Equity but it will be definitely below 10,000 per month and most probably will be the same amount (could be 2000 per month per fund). Do you consider this as balance? I will open account with the same minimum amount. Is it balance? It is not 20-50-30.
Hi Jeffrey.
Yes, the SS Flexi Fund is okay. But I would advise that once you have 1 year worth of expenses invested there (as your emergency fund), you should funnel some of the money to moderate and high risk investments so you could earn more.
Moreover, P2,000 per fund per month for the Balanced and Equity fund is already a good amount to start with.
Lastly, don’t worry too much on the 20-50-30 proportion, important thing is to start now, then rebalance your portfolio after a year maybe.
I already have 100k in SSS Fund, after learning all these investment instruments, I am planning to keep it but to reduce the monthly to maybe 3500 per month to continue to grow , low yield though. Is that ok? But 91 day Tbill rate is lower than interest in banks?
Then the remaining 6500 I will add to the moderate and high risk cost averaging. Does it make sense? Is RetailTreasury Bond moderate? What are moderates?
Fitz,
Really nice article (and series). Rebalancing is an often misunderstood and very counter-intuitive endeavor. Many people don’t realize it’s a powerful tool to manage risk and make sure your portfolio does not fall victim to huge market shifts.
As far as rebalancing strategies go, there are typically two ways to go about it: a time-based strategy and a threshold strategy. A time-based strategy is when you pick a specific schedule to revisit your portfolio to rebalance (ex, monthly, quarterly, yearly, etc.). This is may be the easiest way to go about rebalancing. You don’t need to follow the movements of your portfolio everyday but you stay disciplined enough to take a few minutes on a set schedule to focus in on it.
A threshold strategy is based on triggers (usually a percentage deviation) from a target allocation. When the securities in the portfolio deviate by 1%, 2%, 5%, 10%, whatever you have set, you go in and rebalance accordingly. This strategy is much more time intensive since you need to monitor the portfolio almost on a daily basis. Professionals are more apt to handling this type of strategy.
At the end of the day, whatever strategy you pick, make sure you stay committed to rebalancing. It’ll help keep peace of mind when the markets are irrational. I cover rebalancing and other investing topics on my blog at getwherewithal.com. Here is one article that may be interesting to read to hammer home similar points you made here: http://getwherewithal.com/?p=483. Hope you enjoy the read! 🙂
Sam Das
Hi Fitz,
I’ve seen you on TFC ANC on the Money…
This series is very helpful, Fitz! Thanks so much for sharing your knowledge and experience! More power! 🙂
[…] You did not diversify your portfolio. Or even if you did, you failed to manage your risk and rebalance your portfolio as […]
[…] Review your financial goals and check if your investments are growing accordingly to meet your targets. It may be necessary to move some of your money towards less risky investments for goals that are coming within the next 2 years. […]
[…] Review your financial goals and check if your investments are growing accordingly to meet your targets. It may be necessary to move some of your money towards less risky investments for goals that are coming within the next 2 years. […]