Portfolio rebalancing is a critical component of investment management. It involves realigning the proportions of assets in a portfolio to maintain a desired risk level or investment strategy. Exchange-Traded Funds (ETFs) are an effective tool for this process due to their liquidity, low costs, and diversification benefits. Below are three diverse, practical examples of using ETFs for portfolio rebalancing.
In this scenario, an investor aims to adjust their portfolio based on economic cycles. The investor initially allocates 60% to equities and 40% to fixed income. After a strong performance in technology, the equities portion has grown to 75%. To rebalance, the investor analyzes sector ETFs focused on technology and healthcare, as they believe healthcare will perform well in the next quarter.
They decide to sell 15% of their technology ETF holdings and purchase a healthcare ETF, bringing the allocation back to 60% equities and 40% fixed income. This adjustment not only stabilizes risk but also positions the portfolio for potential growth in the healthcare sector.
An investor with a diversified portfolio has 50% allocated to domestic equities, 30% to international equities, and 20% to bonds. After a year, the domestic equities perform exceptionally well, increasing their allocation to 65%. To manage risk and maintain the desired allocation, the investor decides to rebalance by selling some domestic equity ETFs.
They sell 15% of their domestic ETF holdings and use the proceeds to invest in an international equity ETF, thereby adjusting the allocation back to 50% domestic, 30% international, and 20% bonds. This strategy not only manages risk but also takes advantage of potential growth in international markets.
A young professional is investing for retirement using a target date ETF, which automatically adjusts the asset allocation as the target date approaches. Initially, the portfolio is heavily weighted toward equities (80%) and less in bonds (20%). As the target date nears, the investor notices that the equity portion has grown to 85% due to market gains.
To maintain the target allocation, the investor decides to sell a portion of their equity ETF and purchase a bond ETF, adjusting the portfolio to 75% equities and 25% bonds. This rebalancing helps in reducing risk as retirement draws nearer.