What is rebalancing and why is it important?
Rebalancing involves selling a little of what has done well, and reinvesting elsewhere - to help keep the portfolio on track to achieve its pre-determined objectives.
Left unchecked a portfolio will naturally increase exposure to the area that is performing best over any one period of time. This can have two negative impacts.
The risk in the portfolio can tilt (for instance an ever increasing exposure to equities if they outperform fixed interest/bonds) meaning that an investor could end up with more or less exposure to the areas of the market than was originally set.
Investment is cyclical in nature and asset types (shares, bonds etc.) come in and out of favour as do investment styles (high yield shares have historically performed well in tougher market environments but have lagged in periods of explosive market performance).
A portfolio that is not rebalanced risks having maximum exposure to a style or area of investment just before it falls out of favour and minimum exposure just before it comes back into favour. Regular re-balancing helps investors to take advantage of the ebb and flow of investment fashion. Given the low cost of rebalancing it makes sense to keep portfolios in line with the investors' chosen mix of assets and associated risks.