Asset allocation and rebalancing: how much equity, and when to rebalance

What asset allocation is

It is how your wealth is divided among the main investment categories: equities (higher expected return, bigger swings), bonds (steadier, lower return), cash (no swings, but inflation erodes it). It determines most of the portfolio's behaviour: how much it grows over time and how far it falls in hard times.

How to decide: three questions

1. When do I need this money? A sum needed in two years shouldn't sit in an equity portfolio; one needed in twenty can. Sums with different deadlines can live in different "buckets" (see the bucket strategy).
2. How much can I afford to lose? That is risk capacity: stable income, other assets, fixed costs. A 30% fall is bearable if you have other income; much less so if you must withdraw to live.
3. How much can I stand? That is risk tolerance, the most underrated: a mix that is "right" on paper is useless if you sell everything in a crash.

There is no percentage valid for everyone. There are choices consistent with your horizon, income and temperament. An independent professional can help you line them up: see fee-only planner.

Why rebalance

Over time the categories that rise weigh more and the portfolio drifts towards more risk than you chose. An example with made-up numbers: you start with €10,000 split 60% equities and 40% bonds (€6,000 and €4,000). If in a year equities rise 20% and bonds stand still, equities are worth €7,200 and make up 64.3% of the total (€11,200). You didn't decide that: it happened on its own.

Rebalancing means restoring the original percentages. Here you would sell about €480 of equities and buy bonds.

When and how

• On a fixed date (once a year) or with bands (when a share drifts 5 points from target). More than once a year is rarely needed.
• With new contributions, if you invest regularly: direct new money to the category below target. It is the simplest way and realises no gains.
• By selling only if necessary: in Italy capital gains are taxed at 26% (12.5% on government bonds), so selling to rebalance has a tax cost. See taxes on investments in Italy.
• In retirement, withdrawals themselves can rebalance: draw from the category that weighs most. We cover this in withdrawal strategies.

You can simulate different return assumptions in the FIRE simulator. This guide is educational and does not point to products or specific percentages.

Sources

• Consob, financial education: diversification and risk
• Money.it, taxation of investments: 26% and 12.5% on gains