Portfolio Rebalancing: Periodically adjusting the allocation of assets in your crypto portfolio to maintain a predetermined target weight for each asset

Portfolio rebalancing is a long-term investment strategy used by traders and investors who have long-term goals. 

It can be used for different types of financial assets, and investors and traders can even decide to use this strategy when they use different types of investment products at once. 

As it happened with many other strategies used in traditional markets, portfolio rebalancing was included by crypto traders and investors in the management of their crypto portfolios. 

In this article, we will define the portfolio rebalancing strategy, analyse the different and most common types of portfolios, assess the advantages and disadvantages of this long-term strategy and present examples of portfolio rebalancing practices. 

What is portfolio rebalancing and how it works

Portfolio rebalancing consists in allocating different assets in predetermined percentages, and rebalancing them periodically when appreciated or depreciated. 

To give you a practical example, let’s say that you want to divide your portfolio as follows: 

• 50% Bitcoin, 
• 40% Ether, 
• 10% Cardano. 

To keep the predetermined proportions, if BTC’s price rises, for instance, by 1%, then you’d need to sell 1% of BTC to buy more ETH and ADA. This is a very simple example, but it already allows us to understand what are the basic requirements to use portfolio rebalancing: 

• Having more than one asset in your portfolio, 
• Use a common quote currency to simplify the way you predetermine different shares. 

The reason why traders and investors use this strategy is the mitigation of risk, but this leads us to another important point: how is it possible to use portfolio rebalancing to meet the different levels of risks afforded by traders and investors?

Types of portfolios

To answer this question, it is important to note that not all traders and investors are equal: they might decide to use different currencies, or choose different allocations, and even different levels of volatility. 

That’s why different investors and traders use different types of portfolios. The most common ones are the following: 

• Aggressive portfolios: this type of portfolio usually gathers assets that historically showed high levels of volatility – to say that in financial terms, assets with a high beta, which shows both a high volatility and a strong correlation with the overall market. A subcategory of this type of portfolio can be considered the speculative portfolios, which usually includes assets that are parts of projects with weak fundamental basis or projects in their early stages – like in the case of IPOs. The latter, even if based on strong financial analyses, still show no historical technical data to try to evaluate the possible future developments of the asset.
• Defensive portfolios – sometimes referred to as conservative portfolios. This type of portfolio includes assets that show low levels of volatility. 
• Hybrid portfolios: this type of portfolio mixes the previous two. 

Different types of investors and traders will choose different types of portfolios, allocate and rebalance assets according to their needs and the financial risk they’re willing to afford. 

A common practice to select the different types of assets is by analysing their market capitalization – which is the product of the number of circulating currencies multiplied by the current price. Usually, cryptocurrencies are divided into three groups: 

• Large cap cryptos, usually considered as the cryptocurrencies with a market cap above $10 billion,
• Mid cap cryptos, between $3 and $10 billion,
• Small cap cryptos, below $3 billion. 

The reason why this categorisation is used is that large cap cryptos are usually less volatile – for the simple reason that they are more liquid, and the level of volatility increases as the market cap decreases. So, for instance, large cap cryptos would be suitable for a conservative investor, while a speculator could choose low (or even micro or nano) cap cryptos for his portfolio. 

So, for example, a defensive investor might choose to allocate 40% of his portfolio in Bitcoin (BTC), 35% in Ether (ETH) and 25% in Tether (USDT), since they are the top three cryptocurrencies by market cap at the time of writing, and then rebalance accordingly. 

Steps to follow to rebalance a crypto portfolio

Let’s recap what investors and traders who rebalance their portfolios need: 

• More than one asset, 
• A common quote currency, 
• A plan. 

The third point is implicit in the definition of portfolio rebalancing: the strategy consists in use predetermined allocations and buying or selling assets periodically, and according to different market conditions, to re-reach the predetermined levels if some assets appreciate or depreciate. 

So, these are the steps to follow to rebalance a portfolio: 

1. Choosing a type of portfolio able to meet investors’ needs;
2. Choosing assets accordingly; 
3. Choosing the intervals at which the investor want to recheck his portfolio: as we mentioned, portfolio rebalancing is a long-term strategy, and like other long-term investment strategies (for instance, Buy-and-Hold or Dollar-Cost Averaging), it doesn’t require the investor to constantly check how the portfolio is performing. Some investors might choose to recheck the portfolio every week, some every month or quarter, and then decide to rebalance according to their findings and the predetermined shares. 

Some investors might even choose to be more flexible, and rebalance their portfolios according to the overall market conditions. 

For instance, an investor might choose to increase the allocation of cryptocurrencies other than Bitcoin during the so-called “altcoin season”. 

Advantages and disadvantages of crypto portfolio rebalancing

As any other investment and trading strategy, portfolio rebalancing has both pros and cons and it is not a risk-free strategy. 

Among the pros, we can list: 

• The reduction of the impact of emotions. Since the investor has predetermined schemes, he will rebalance accordingly, without involving any type of emotion, but just respecting the different allocations. 
• Portfolio rebalancing requires a certain level of diversification – as mentioned, it requires at least two assets for the strategy to be applied. 
• It is able to always respect the level of risk the investor is willing to afford. In fact, it is exactly the level of risk that allows investors to choose different types of portfolios and allocations. 

On the other hand, portfolio rebalancing doesn’t protect the investor from risks. The fact that it requires precise plans and a certain discipline, also means that the investor won’t choose according to market development in most cases. 

For example, an investor who rebalances the portfolio once a week, could notice that the appreciating asset outperformed his expectations. Nevertheless, he will sell to respect the initial allocation. In this case, the decision isn’t based on technical analysis, but on the overall goal to protect the whole portfolio over time. 

Of course, and especially in cases of highly volatile assets, the initial expectations of the investor might be wrong, and actually decrease the value of the portfolio over time. 

Example of crypto portfolio rebalancing using real data

To dive deeper into the topic, let’s see an example of rebalancing that takes into account a defensive portfolio – considering real historical data. 

Example of rebalancing of a Defensive portfolio

Let’s see an example of a defensive portfolio worth $4,000 that includes the current three cryptocurrencies by market cap – BTC, ETH and USDT. 

The allocation is as follows: 

• 40% of BTC, 
• 35% of ETH, 
• 25% of USDT. 

The portfolio is rebalanced every quarter during 1 year. 

	April 2021	July 2021	October 2021	January 2022	April 2022
Price of BTC	$59,095.81	$33,572.12	$48,116.94	$47,686.81	$46,281.64
Price of ETH	$1,977.28	$2,113.61	$3,307.52	$3,769.70	$3,449.55
Price of USDT	$1	$1	$1	$1	$1

Source of historical data: CoinMarketCap

• April 1, 2021. The portfolio includes $1,600 worth of BTC, $1,400 of ETH and  $1,000 worth of  USDT. This means that, at the prices shown in the table, the portfolio includes around 0.027 BTC, 0.708 ETH and 1000 USDT.

• July 1, 2021. Being a stablecoin, the price of USDT doesn’t change (at least, not significantly). BTC depreciated – by 43.19%. On the contrary, ETH appreciated – by 6.89%. The investor’s portfolio, before the rebalancing, would be worth $3,402.88 – it lost value. Now, BTC would represent 26.64% of the portfolio ($906.45), ETH would represent 43.98% of the portfolio ($1,496.43), and USDT 29.39% of the portfolio ($1,000). 

To rebalance the portfolio, the investor needs to get rid of USDT and ETH to buy BTC, and do the following: increase the BTC position to $1,361.15 – almost 0.041 BTC; decrease ETH allocation to $1,191.01 – around 0.56 ETH, and USDT allocation to 850 USDT.

• October 2021. BTC appreciated – by 43.32%. ETH appreciated – by 56.49%. Before rebalancing the portfolio, it is worth ((0.041 BTC * $48,116.94) + (0.56 ETH * $3,307.52) + (850 USDT)) = $4,675. The whole portfolio appreciated in value compared to April 2021. BTC now represents 42.2% of the portfolio ($1,972.80), ETH is 39.62% ($1,852.21) and USDT represents 18.18% of the portfolio ($850). 

The investor now needs to decrease the allocation of BTC and ETH, and increase the allocation of USDT. The portfolio now includes 0.039 BTC ($1,870), 0.49 ETH ($1,636.25), and 1168.75 USDT ($1,168.75) – to respect the initial allocation. 

• January 2022. BTC depreciated – by 0.89%. ETH appreciated – by 13.97%. Before rebalancing, the portfolio is worth ((0.039 BTC * $47,686.81) + (0.49 ETH * $3,769.70) + 1168.75 USDT) = $1,859.78 + $1,847.15 + $1,168.75 = $4,875.68. 

So, now BTC represents 38.14% of the portfolio, ETH is 37.88% and USDT is 23.97% of the whole portfolio. The investor needs to increase the shares of BTC and USDT, and decrease the share of ETH. 

The rebalanced portfolio now includes 0.04 BTC ($1,950.27), 0.45 ETH ($1,706.49) and 1218.92 USDT ($1,218.92). 

•  April 2022. BTC depreciated – by 2.95%. ETH depreciated, too – by 8.49%. Before rebalancing, the portfolio is worth ((0.04 BTC * $46,281.64) + (0.45 ETH * $3,449.55) + $1,218.92) = ($1,851.26 + $1,552.30 + $1,218.92) = $4,622.48. 

At the end of the year, the value of the portfolio increased – from $4,000 to $4,622.48. The portfolio rebalancing strategy managed to protect and even increase the value of the portfolio. 

Conclusion 

Portfolio rebalancing is a long-term investment strategy used to protect or increase the value of a portfolio over time. 

Investors who want to use this strategy need at least two assets and a plan: over time, the investor buys or sells assets to keep the predetermined shares he chose in the beginning, and he rechecks the portfolio at specific intervals he chooses. 

Of course, this strategy is not risk-free, but among its pros we can list its capability to remove emotional trading. 

Not all investors and traders are equal, and they usually choose the portfolio rebalancing strategies and allocations according to the level of risk they’re able to deal with. 

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