As a crypto investor navigating the dynamic landscape of digital assets, you’ve likely encountered the challenge of maintaining a well-balanced portfolio. The volatile nature of the crypto market constantly shifts the values of your holdings, prompting the need for a strategic approach known as crypto portfolio rebalancing.
Rebalancing your crypto portfolio is a strategic realignment of asset weightings to restore them to their original proportions. Let’s illustrate this with an example: imagine you initially allocate 50% to Bitcoin (BTC) and 10% each to Ethereum (ETH), ADA, DOGE, MATIC, and DOT. Due to market fluctuations, DOGE’s value surges, causing its allocation to rise to 15%. To rebalance, you’d sell some DOGE and buy ADA to reinstate the original 10% allocation for each.
This process is viable when you hold multiple digital assets, assigning percentages based on a fiat currency equivalent. For instance, a $100 portfolio might have $50 in BTC and $10 each in other assets. As values fluctuate, rebalancing ensures you sell overperforming assets and buy underperforming ones, maintaining the desired allocation.
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.
Crypto Portfolio Rebalancing Strategies
Threshold Rebalancing
In this strategy, the trader proactively adjusts the allocations of assets when they deviate beyond a specified tolerance band. The tolerance band represents an acceptable range within which the asset allocations are allowed to fluctuate. When an asset’s value surpasses the predetermined threshold, the trader initiates rebalancing by either selling or buying assets to bring them back within the desired range. This approach is particularly effective for those who prefer a hands-on approach to managing their portfolio, reacting promptly to significant market movements.
Constant Proportion Portfolio Insurance (CPPI)
Unlike threshold rebalancing, CPPI is a risk management strategy that focuses on allocating a portion of the portfolio to stable assets, aiming to protect against market downturns. The core idea is to have a dynamic allocation strategy that adjusts based on the perceived risk in the market. When market conditions indicate increased risk, funds are shifted into more stable assets to safeguard the overall portfolio value. This method allows investors to navigate market volatility with a structured approach, aiming to minimize potential losses during turbulent periods.
Calendar Rebalancing
The investor adjusts the portfolio based on a predetermined time interval in the calendar rebalancing strategy. This approach is less reactive to market fluctuations and follows a systematic schedule. For example, an investor might choose to rebalance their portfolio on a monthly, quarterly, or yearly basis. The time interval serves as a regular checkpoint to ensure that the portfolio remains aligned with the original asset allocation goals. While it may not respond immediately to sudden market changes, calendar rebalancing provides a disciplined and predictable method for maintaining a balanced portfolio over the long term.
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 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%.
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 and the best way for Optimization Crypto.
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