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Exploring Mutual Funds – The Importance of Rebalancing Your Portfolio

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect

Over the last few articles, we kept going back to the importance of having a diverse mix of investment types (equities, bonds and short-term financial assets) according to a purposeful asset allocation plan. The idea is to help you manage volatility and maximise growth opportunities over time, while also minimising the risks of over-exposure to any particular asset class. On the other hand, you need to bear in mind that diversification cannot guarantee you a profit or protect you against loss in a declining market because all investments involve risk. But the intention is that the asset allocation you have decided on, on your own or with your Financial Advisor, provides the framework for your investment strategy. This brings us to today’s subject – rebalancing.

Rebalancing is a jargon word used frequently in the investment world. It is an administrative exercise that you periodically carry out on your investment portfolio, possibly once or twice a year. You do some tinkering so that your portfolio looks like the way you originally intended it to be in terms of asset allocation and also check that it is performing how you originally wanted it to work. The only way to return your investment portfolio to the original asset allocation between equities, bonds and cash is by buying and selling some of your holdings until your reach your original allocation. That is rebalancing. You sell your over-weighted assets and buy into the underweighted assets.

Periodically rebalancing a diversified portfolio help you mitigate risk. It involves shifting money on a regular basis from assets that have performed well to those that have been lagging. The purpose of this exercise of rebalancing is to help you reduce portfolio volatility and help you minimise the emotional anxiety that you may feel at times of high market volatility. Rebalancing prevents you from continuing to increase risk exposure to certain asset classes or sectors, when markets are performing well and at the same time it offers you the opportunity to take advantage of stock market declines with lower investing prices.


Let us take an example where your intended asset allocation is to have 60% equities, 30% bonds and 10% short-term investments including cash. Over a long period of time, if left unchecked, that portfolio could sway in a completely different distribution, because some asset classes will grow faster than others. The original allocation should reflect your investment objective and your risk tolerance. Besides, as you grow older you would typically grow more conservative, so even if the percentage of the respective asset class in your portfolio were to remain the same as when you started out, then your asset allocation will be out of sync with your target and present risk profile. It is therefore important to self-assess your financial outlook and investment objectives and ensure that they have not changed. If your investment objectives change, then you might be required you to change your asset allocation.

Going back to our example, let’s say that you have found that your equity allocation has suddenly shot up to 70%, you will need to take steps to adjust the allocation to your 60% equities target. It is important that you stick to your original target as otherwise the risk of your portfolio will be considerably higher, than when you started. It is also important to take a look at the subsectors within each asset class. For example, imagine your equity holdings were invested in large-cap stocks (70%), in small- and mid-cap stocks (20%), and the remaining 10% invested in emerging markets. If large-cap stocks generally performed better than other sectors, your allocation to that subsector may exceed 70%, so it might be appropriate to buy more shares of small- and mid-cap and emerging market equity funds than large-cap stock funds to bring your portfolio back to your target allocation.

Many of you will not feel comfortable managing your own portfolio allocations and prefer not to do the rebalancing by yourself. If that is the case, then do consider contacting your Financial Advisor at MeDirect, who will be able to assist you with this exercise. The Advisor will be able to look at the mix of stocks and bonds of your mutual funds and your short-term investments for your specific time horizon. He/she will be able to provide you with good diversification across the market in large-cap, small-cap, and emerging market equities, a variety of bonds and if need be bank accounts, depending on your objectives and risk profile.

Frequency of Rebalancing

You should not be rebalancing too often, since the exercise involves taxes (such as capital gains tax) and transaction costs (when buying and selling your mutual funds) that you would have to pay. Morningstar, MeDirect’s partners, recommend that you should use a simple strategy of restoring your cash and bond funds holdings to their original weightings if they swing between 5 to 10 percentage points outside the original allocation and this should help lower your portfolio’s overall risk. One way of reducing taxes it so rebalance by adding new money to the asset classes and categories that have lagged rather than selling winning holdings.

As we mentioned already, it is a good idea to review your investment portfolio at least once a year. You should ensure that your asset allocation continues to be in place according to your investment objectives and your time horizon. At the same time, you should not react to every significant market movement that takes place.

After a year of steep declines, it may feel “safer” not to take any action at all, but waiting to rebalance could increase your inflation risk (and a fall in value of your portfolio) if your imbalanced portfolio has less growth potential than your original targeted allocations. For long-term goals, such as retirement, the risk of a portfolio, which has been left unattended, could potentially do more harm than the occasional market declines.

Rebalancing is an important part of long-term investing. At least once a year, you should compare your investment portfolio to your ideal asset allocation – with the right mix of equities, bonds, and short-term investments for your investment goals. Then make changes by selling and buying shares of investments to realign your portfolio to your desired target. Striking a balance that keeps your portfolio broadly aligned with your target asset allocation, while ensuring you aren’t trading too frequently and racking up costs will see you well placed to achieve your goal. It is never a bad idea to call you your Financial Advisor or your Relationship Manager and ask them for their advice. They can answer your questions and help you steer in a good direction.

The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.

MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370). 

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein. 

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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