Rebalancing refers to adjusting the weightage of assets within a portfolio.
It involves periodically buying or selling assets to maintain a desired asset allocation level and manage risk.
This strategy allows investors to mitigate downside risks while benefiting from potential gains.
During financial instability, rebalancing becomes crucial in helping individuals reduce the risks of asset loss and depreciation.
It prevents overexposure to specific assets and cultivates disciplined trading habits by adhering to a long-term financial plan.
Monitoring market movements allows investors to make necessary adjustments and avoid potential losses.
Maintaining Optimal Portfolio Allocations
Rebalancing strategies are often based on specific periods, such as yearly, quarterly, or monthly intervals.
They can also be reactionary, depending on allowable percentage compositions of assets, which may incur higher costs.
For instance, if the original target asset allocation was 50% for assets A and B, and asset A performed well, its increased weighting in the portfolio could skew the allocation to 70%.
In such a scenario, the investor may sell some of asset A and purchase more of asset B to restore the original 50/50 allocation.
While the allocation need not be equal among assets, effective rebalancing involves a balanced mix of volatile and non-volatile holdings in the portfolio.
This approach safeguards investors from excessive exposure to undesirable risks.
Automated Rebalancing in DeFi
In traditional finance, investors can manually do rebalancing, track their portfolios through spreadsheets, and execute buying and selling transactions through exchanges or brokers.
Alternatively, investors can invest in funds where portfolio managers handle the rebalancing process.
Rebalancing in decentralized finance (DeFi) offers certain advantages, allowing for automated execution through smart contracts.
This eliminates the need for constant monitoring of the portfolio and cross-checking asset values against stock markets.
DeFi users can automate rebalancing, distributing gains across their assets while ensuring a net positive overall gain.