How to Rebalance a Cryptocurrency Portfolio Effectively
A strategic investment portfolio is typically created with target goals, like predetermined investment allocation or risk-to-reward ratio. As you trade any assets, price swings inevitably result in differences between the current investment value and the initial cost. Your investment sizes naturally grow or shrink according to the asset values. This shifts the balance of your portfolio in percentage terms for each investment, also changing the risk level of each investment.
Portfolio rebalancing is a strategic tool that safeguards traders against overexposure to unplanned risk. Rebalancing involves buying or selling assets to return to a preset asset allocation.
We’ll show you how portfolio rebalancing works, why rebalancing regularly is important, and a few of the top rebalancing strategies available. Follow along with our step-by-step guide for specific guidance on how to rebalance your portfolio.
What is Portfolio Rebalancing?
Portfolio rebalancing is to realign the asset weightings within an investment portfolio to rebalance risks. Rebalancing occurs periodically and involves buying or selling cryptocurrencies or other investments held in a portfolio to reach the target level of risk or asset allocation.
Traders can implement portfolio rebalancing alongside existing trading strategies as a risk mitigation technique. You can also use portfolio rebalancing as a stand-alone investment strategy, often praised as a promising alternative to HODLing.
Why Rebalance a Portfolio?
The primary benefit to regular portfolio rebalancing is the return to a strategically determined level of risk that it provides. However, this isn’t the only benefit. Rebalancing combats the psychology of wanting to hold on to winners — and letting them remain an outsized portion of your portfolio. You’ll also naturally average into a better price on losing positions. By not letting the psychology of market moves affect your strategy, you eliminate emotions from the equation. From this vantage point, it’s much easier to make a rational, logical evaluation of your risk tolerance and to decide on the necessary trading strategy for your crypto portfolio.
Traders often use larger market capitalization currencies like Bitcoin and Ether to limit volatility and minimize risk while investing. The more you begin to diversify toward high volatility crypto assets and medium-to-low market capitalization coins and tokens, the more frequently you may need to rebalance your crypto portfolio. Asset values can plummet or skyrocket in minutes, thereby changing investment sizes quickly. Some seasoned traders in the rapidly evolving crypto world carry out portfolio rebalancing on the hour, every hour.
Can Digital Assets Be Rebalanced?
Digital assets are among the most suitable investments for regular portfolio rebalancing. Markets never close, meaning you can continue to rebalance at any time of day. Intentional periodic assessments are essential to staying on top of risk and aiming for your predetermined balance of assets.
There are many available tools to help you track and rebalance your crypto portfolio. Here are a few of them:
CoinTracker — Connect to over 300 exchanges or wallets and track over 8,000 cryptocurrencies, letting CoinTracker keep a record of all your fees while sorting out tax reports, thanks to the intuitive and easy-to-use interface.
Kubera — Track stocks or cryptocurrencies with Kubera’s highly functional (but as-easy-as-a-spreadsheet-to-operate) portfolio tracker, offering bank and brokerage connection for total investment tracking and management.
Shrimpy — Shrimpy is a crypto portfolio rebalancing tool that offers portfolio tracking, rebalancing, and automated index and copy trading. Automate your own system, or follow another trader.
Top Rebalancing Strategies
Here are three common cryptocurrency portfolio rebalancing strategies. The best strategy depends on your portfolio, risk tolerance, diversification goals, and general approach to trading.
You can test out these strategies on your own portfolio.
For example, the concept of rebalancing revolves around the size allocated to assets within the portfolio. Typically this is considered in percentage terms. For example, if you have a $10,000 portfolio, with $2,500 invested in four different coins, each coin would have a 25% allocation in the portfolio.
Allocation Percentage = Amount invested in a coin / Amount invested in total portfolio
You start out typically with a desired allocation percentage, and then as the value of each cryptocurrency changes, you end up with the actual allocation percentage. Rebalancing is the practice of bringing your actual allocation percentage back in line with the desired allocation percentage.
Periodic portfolio rebalancing is a straightforward, time-based approach to resizing investments. The trader decides an initial investment allocation between various cryptocurrency coins and tokens.
After a fixed time period — which could be hours, days, or weeks — portfolio assets are bought or sold in the proportions necessary to return to the desired asset allocation. Even if the portfolio is out of balance on a percentage basis, rebalancing doesn’t occur if the time period hasn’t been reached.
Example: You can choose to divide your portfolio equally between four different digital assets (BTC, ETH, SOL, DOGE). Each coin would take up 25% of your portfolio initially. At your chosen time interval, let’s say one week, you would check if your actual allocation percentage, as determined by the current coin values, has changed from 25%. If it has, then you would buy and sell the assets accordingly to bring each allocation percentage back to your desired 25% level.
Percentage Portfolio Rebalancing
Percentage portfolio rebalancing defines absolute percentage-based allocations to investments and a band of allowable deviation. If any of the coins owned rise or fall past the target amount and the tolerated corridor, the trader rebalances the entire portfolio back to the desired allocations.
Example: Using the previous example, your desired allocation percentage is 25% per coin. You then choose an absolute allowable deviation of +/-5%. This means that the allocation percentage of a coin can move down to 20% or up to 30% of the portfolio without rebalancing. Anything past those bands would require rebalancing.
The portfolio owner sets initial target allocations and a percentage of deviation relative to those allocations, serving as the “threshold.” This method uses a percentage calculation of the threshold rather than an absolute percentage difference.
For example, referencing the previous example, your desired allocation percentage is 25% coin, and your threshold is a 10% deviation. Your allowable deviation in absolute percentage terms is 10% x 25% = 2.5%. So your actual allocation percentage can only go down to 22.5% or up to 27.5%. Any sizes outside of this threshold would be rebalanced.
Another one of the good threshold rebalancing strategies includes if the target allocation is 10% per investment and the threshold is 10%, then rebalancing would occur if the allocation changes by more than 10% of the goal. Ultimately, the idea of threshold rebalancing will normally only be triggered when there is a significant shift in your asset allocation.
Generally, there are two major types of threshold levels that suit your risk tolerance:
- Frequent portfolio rebalancing
- Happens in a steadier market
- Lower potential returns
- Portfolio is closer to the target
- Lower rebalancing rate
- High volatility markets
- Higher potential returns
- High risk-to-reward ratio assets
When the risk-to-reward ratio is high, it naturally translated to the high threshold level. But that also means that you need a decent level of risk management.
How to Rebalance a Portfolio
Follow this step-by-step guide to learn how to rebalance your cryptocurrency portfolio and manage risks in the volatile crypto market.
Step 1 — Decide Which Type of Portfolio Balancing Suits Your Investment/Trading Style
The trader’s investment strategy and style largely determine the type and frequency of portfolio rebalancing necessary. Higher risk investments — such as volatile coins, newly launched tokens, and those with limited market capitalization — typically require more frequent rebalancing than a portfolio with one or two stable currencies and a single high-risk token or two. Decide which rebalancing strategy suits your unique approach and risk tolerance before moving on to the starting allocation of your investment.
Step 2 — Assign Your Starting Crypto Asset Allocation
Determine the initial investment mix and balance. If you’ve already started trading, then divide up your existing portfolio into the crypto asset allocation you’d prefer based on your risk management strategy and the assets you own. For example, an investor may hold 40% of their portfolio value in a large market capitalization cryptocurrency like BTC, 20% in ETH, and have the remaining 40% invested into two ICOs and two altcoins evenly at 10% each.
Step 3 — Rebalance Your Cryptocurrency Portfolio
If you’re rebalancing based on a schedule using a periodic strategy, then buying and selling the coins or tokens needed to reach your predetermined investment allocation is fairly straightforward. Alternatively, you can use portfolio or threshold rebalancing. Threshold rebalancing involves setting a percentage deviation from your allocation that you don’t want to be breached. Percentage rebalancing adjusts allocations based on absolute changes in your percentage allocation.
Step 4 — Make the Trades
Buy and sell the crypto assets that will take your cryptocurrency asset allocation back to your original goals. If you’re rebalancing manually without the help of crypto portfolio rebalancing tools, then you’ll need to try to execute transactions as close together as possible. You’ll also need to log each transaction to compare investment performance at a later stage accurately and to track capital gains for tax purposes if you’re in the U.S.
Whether or not you need to record all rebalancing transactions depends on your local applicable tax laws. Keeping a record of all trading activity is, however, generally recommended for analysis purposes. For tax purposes, recording rebalancing transactions is essential to maintaining compliance and claiming capital losses or gains.
How Often Should You Rebalance a Portfolio?
Rebalancing a diverse portfolio helps you take profits and realign your risk levels. Research into rebalancing and cryptocurrency portfolio diversification from Hacker Noon showed that portfolios with more cryptocurrency coins and tokens had the highest performance potential from hourly portfolio rebalancing. The reported gains in portfolio growth when rebalancing hourly, as opposed to HODLing, rose as high as 234%.
The Bottom Line
Whether you choose to carry out portfolio rebalancing of your crypto portfolio every hour, once a day, or annually, regular rebalancing is a fundamental component of working within your risk tolerance and maximizing the return on your investments. Decide on a rebalancing strategy today, and consider trying out a few reliable crypto portfolio rebalancing tools. Each one will be suited to a particular trading style and can make rebalancing a portfolio infinitely easier to manage.