Rebalancing consists of intermittently re-aligning assets with your strategy. That means periodically making tweaks to your asset allocation to ensure that you maintain your desired risk profile and take advantage of any new opportunities in the market.
What is portfolio rebalancing?
Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original state.
Rebalancing is only possible for investors with a diversified cryptocurrency portfolio. This means that you cannot tweak your asset allocation if you only own a single cryptocurrency (e.g., Bitcoin). Consequently, rebalancing and diversification go hand-in-hand. In our previous article, we already discussed how to diversify your crypto portfolio based on your desired level of risk and your preferred asset allocation.
For example, say your original target asset allocation was 50% Bitcoin and 50% Altcoins. If Bitcoin performed well during the period, it could have increased the Bitcoin weighting of the portfolio to 70% or even 85%. You may then decide to sell some Bitcoin and buy Altcoins to get the portfolio back to the original target allocation of 50/50.
Why is rebalancing important?
Rebalancing offers a lot of benefits, without losing many of the benefits of HODLING. HODLING, a common slang term in cryptocurrency, refers to holding an investment over time, regardless of short-term changes in the market. Essentially, this means buying cryptocurrency and waiting for years as the market continues to grow.
Rebalancing still allows you to buy now and hold onto an investment as long as you’d like. It also reserves you the opportunity to adjust planned long-term investments that fall off their trajectory.
- Manage your risks: Asset allocation is about balancing risk and reward. Invariably some asset classes will perform better than others. As a result, the percentage that you’ve allocated to different asset classes will change. This can cause your portfolio to be skewed towards an allocation that takes too much risk or too little risk based on your financial objectives.
- Maxime chances of profitability: by selling the assets that are outperforming, and buying the underperforming ones, you will benefit from the buy-low and sell-high strategies
- Keep control of your portfolio and emotions: Warren Buffet’s most famous quote states “if you cannot control your emotions, you can’t control your money”. By having and keeping a consistent strategy, you can avoid FOMO (Fear of Missing Out) or FUD (fear, uncertainty, and doubt.)
However, one of the disadvantages of rebalancing is that sometimes you cut the legs out from under the asset class before it has finished its bull run.