The Importance of ETF Rebalancing: Why It Matters for Investors

Portfolios shouldn’t stay stagnant once you make them. Investors who didn’t change their portfolios since the 1980s would have missed out on incredible opportunities. These same investors may have also seen some of their favorite companies go bankrupt or experience significant declines. Stocks that comfortably outpace the market today may become laggards within a few years. Exchange-traded fund (ETF) rebalancing helps investors get exposure to promising opportunities and leave unpromising investments behind.

What is ETF Rebalancing?

ETF rebalancing is the process of changing asset allocations within the fund. A fund manager looks at market opportunities to see how the portfolio stacks up. They may decide to trim risky positions and accumulate shares of promising stocks. ETF rebalancing can also help the fund manager stay on target with an index the fund aspires to mirror. For instance, the recent Nasdaq 100 composite rebalance forced many ETFs to adjust their portfolio concentrations based on changes to the Nasdaq 100 index.

How Often Should ETFs Be Rebalanced?

It’s not a good idea for ETFs to be rebalanced too often. More rebalancing can trigger more fees and capital gains. However, occasional ETF rebalancing can help a fund achieve higher returns and minimize risk. Many fund managers rebalance ETFs one or two times per year. Some funds get rebalanced more often, including daily. Each of these rebalances means more fees that investors incur, so you should be wary if an ETF rebalances daily or weekly.

The Importance of Portfolio Maintenance

Your money is extremely important. Saving and investing can help you retire earlier and make previous unattainable goals feel within your grasp. Many consumers use stocks, ETFs and similar assets to build wealth quicker, but all of these assets contain risk. When things go wrong, stocks and ETFs can lose significant value. Portfolio maintenance allows investors to stay on top of their holdings, make adjustments to minimize risk and chart their path to financial independence. ETF rebalancing contributes to portfolio maintenance, and a fund manager will do this for you.

Benefits of ETF Rebalancing for Investors

ETF rebalancing offers several advantages for investors. You may benefit if you hold onto ETFs as fund managers rebalance the holdings.

Preservation of Investment Objectives

Rebalancing assets allows ETFs to maintain their objectives. If an ETF aims to provide high yields for investors, it would make sense for those ETFs to remove dividend stocks that pause or cut their dividend payments. Rebalancing a high-yield ETF can remove dividend stocks that no longer contribute to fund distributions.

Maximizing Returns By Buying Low and Selling High

During a rebalance, fund managers have the opportunity to sell some of their high fliers and build positions for stocks that have had a rough few months. Buying low and selling high allow fund managers to deliver higher returns for their investors.

Reducing Market Timing-Related Risks

ETF rebalancing doesn’t happen often for passive funds. Fund managers look for attractive long-term opportunities once or twice per year, but some managers rebalance their portfolios more frequently. Being less involved in the market and letting long-term investments develop makes you less vulnerable to risks related to market timing.

The Impact of Market Changes on ETFs

Stock market changes impact ETFs. A bullish market strengthens ETFs with long positions, while a bear market delivers better returns for ETFs that short stocks. An ETF rebalance can mitigate the effects of volatile price swings within the market. Fund managers can access market conditions when rebalancing their portfolios to position themselves for a recession or economic boom, depending on which outcome seems more likely. 

ETF Rebalancing Strategies

Fund managers incorporate several rebalancing strategies to determine when to rebalance their ETFs. Here are some of the top ETF rebalancing strategies:

• Calendar rebalancing: Fund managers decide on a calendar frequency to conduct rebalances, such as monthly or quarterly. Some funds rebalance their holdings semi-annually. Weekly rebalances are also an option, but the fees are higher for those funds.
• Percentage-of-portfolio rebalancing: Some fund managers aim for equally weighted positions. If one stock rallies, a fund manager will sell off shares of the winning stock and spread them among the other positions. This process enables all positions to maintain a similar percentage of the total assets under management.
• Threshold rebalancing: A rebalance can take place if an asset takes up too much of a portfolio. For instance, some ETFs aim for 60% stocks and 40% bonds. If this 60-40 portfolio becomes a 70-30 portfolio due to rising stock prices, the fund manager may rebalance the ETF. This rebalance would bring the portfolio back to 60-40.

Monitor Your Portfolio

Rebalancing your portfolio can help you capitalize on new opportunities without leaving yourself overexposed to an asset. ETF managers rebalance portfolios for investors so they don’t have to worry about it. Investors should monitor their portfolios even if they only invest in ETFs. Looking over your portfolio and searching for investment opportunities can help you craft a better portfolio that aligns with your financial goals. 

Frequently Asked Questions