10.6 Monitoring and Rebalancing - 10.6 Monitoring and Rebalancing

Key Concepts

• Monitoring Portfolio Performance
• Rebalancing Strategies
• Trigger Points for Rebalancing
• Benefits of Rebalancing
• Challenges in Rebalancing

Monitoring Portfolio Performance

Monitoring Portfolio Performance involves regularly tracking the returns and risk metrics of a portfolio to ensure it aligns with the investor's objectives and risk tolerance. This includes comparing the portfolio's performance against benchmarks and peer groups.

Example: An investor reviews their portfolio quarterly to check if the returns are in line with their target of 8% annual growth and whether the risk level remains within their comfort zone.

Rebalancing Strategies

Rebalancing Strategies are methods used to restore a portfolio to its original asset allocation after deviations occur due to market movements. Common strategies include periodic rebalancing, threshold-based rebalancing, and tactical rebalancing.

Example: A portfolio initially allocated 60% stocks and 40% bonds. After a year, stocks have outperformed, increasing the allocation to 70% stocks and 30% bonds. The investor rebalances by selling some stocks and buying bonds to return to the original 60/40 split.

Trigger Points for Rebalancing

Trigger Points for Rebalancing are specific conditions or thresholds that, when met, prompt the adjustment of a portfolio's asset allocation. These can be time-based (e.g., annually), deviation-based (e.g., when an asset class deviates by 5%), or event-based (e.g., significant market changes).

Example: An investor sets a trigger point for rebalancing when the stock allocation deviates by more than 10% from the target. If stocks rise to 70% of the portfolio, the investor rebalances to maintain the desired risk level.

Benefits of Rebalancing

Benefits of Rebalancing include maintaining the desired risk level, ensuring alignment with investment objectives, and mitigating the effects of market volatility. Rebalancing also helps in capturing gains and reducing losses by selling overvalued assets and buying undervalued ones.

Example: Regular rebalancing helps an investor avoid overexposure to high-risk assets during a market boom and ensures sufficient exposure to defensive assets during a downturn, thus preserving capital.

Challenges in Rebalancing

Challenges in Rebalancing include transaction costs, tax implications, and behavioral biases that may hinder timely adjustments. Additionally, frequent rebalancing can lead to reduced returns if market trends continue in the same direction.

Example: An investor faces a challenge when rebalancing involves selling stocks that have appreciated, triggering capital gains taxes. This cost must be weighed against the benefits of maintaining the desired asset allocation.