Hey, it's Colton from Hedgehog, the easiest way to maintain a diversified crypto portfolio. Today I want to explain why rebalancing is important. It's a central feature of Hedgehog and an investment practice with substantial benefits, no matter what you're buying and selling.
Number Go Up, Number Go Down
As the name implies, rebalancing brings your investment portfolio back to a balanced state. What is that balance? In theory, whatever you want it to be. The point is that asset prices rise and fall, so if you’re trying to maintain a particular ratio of this asset to that asset, or trying to match a particular benchmark, you’ll need to periodically buy and sell to do so.
For example, TradFi investors often intend to maintain a particular mix of stocks versus bonds. Or you might want to keep 30% of your portfolio in foreign assets and 70% in domestic ones. Over time, if the foreign investments did particularly well, you would have to sell some to bring that portion back down to 30% of the overall value of your portfolio.
If you invest in an index fund, the managers of that fund do the rebalancing for you — as stock prices move up and down, and the market caps of the companies fluctuate, the fund managers adjust the proportions of each stock owned within the fund to align with the index.
However, if you manage your portfolio independently, you need to take on this task yourself. Steps include setting a desired asset allocation, deciding when and how often to rebalance, monitoring your portfolio's actual asset allocation, and executing the necessary trades to achieve your decided balance.
Orrrr, when it comes to crypto, you can use Hedgehog to automatically handle this work for you 😎
Rebalancing isn't just about selling high performers. It also incorporates buying more of the low performers. Why do that? To build a more diversified portfolio — buying low and selling high, often going against the general investor sentiment of chasing high-return investments as they reach ever greater heights. Doing the opposite serves as a type of insurance against potential market volatilities.
But wait, don't you want more of the highest-performing assets? Maybe, but the more of your portfolio is invested into a particular asset, the greater the risk that asset poses. What if it crashes? Continual rebalancing ensures the risk levels of your portfolio don't drift off substantially from your comfort zone.
Also, while keeping your portfolio's overall configuration consistent, rebalancing indirectly forces you to develop a disciplined approach towards investing, instead of making emotion-driven changes from moment to moment. Despite changing conditions in the financial world, you steer your investments in accordance with your financial goals.
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Intriguing. Reminds me of when it was a big deal to vote for American Idol contestants via text.
Until next time, keep hedging,