Chapter 7: Basics of Portfolio Building
Portfolio rebalancing is a specific type of asset allocation strategy that is widely used, warranting its own chapter.
Essentially, it involves periodically, often at the end of the year, selling some of your winning stocks and either buying new ones or purchasing more of your losing stocks.
This practice helps mitigate risk by preventing any single holding from becoming too large within your portfolio.
When should you balance your portfolio?
As always, it depends on your risk tolerance. If you have a very low-risk tolerance, rebalancing once a stock reaches 5% of your entire portfolio might be a good idea.
Others might feel comfortable with a threshold of 15%.
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Consider how much impact you can handle if one stock were to drop by 50%. If you feel uncomfortable seeing 4% of your portfolio disappear due to such a drop, then rebalancing once a stock reaches 8% of your entire portfolio would be a prudent strategy. Similarly, if you feel uncomfortable with your portfolio losing 6%, then rebalance when a stock reaches 12%.
Essentially, rebalance at twice the percentage you would be unhappy to lose from your portfolio.
Be careful of overdoing it
Considerations for Rebalancing
One of the most powerful factors in investing is stock momentum, as success tends to breed further success. If you rebalance too often, you might inadvertently stifle your gains. Conversely, buying a losing stock that continues to decline can also erode your portfolio's value.
Strategic Approach to Rebalancing
We believe the best approach is to avoid buying your losing stocks unless you have a very specific and well-founded reason to do so, along with a solid thesis on why they are down. This strategy helps ensure that you are making informed decisions rather than reacting impulsively to market fluctuations.