What is one of the consequences of rebalancing a portfolio?

Rebalancing a portfolio is the process of realigning the proportions of assets in the portfolio to maintain the desired level of risk or to meet specific investment objectives. One key consequence of rebalancing is the potential reduction in the level of portfolio risk.

When a portfolio is rebalanced, it typically involves selling securities that have increased in value and buying those that have decreased to bring the asset allocation back in line with the investor's target allocation. This process can help mitigate risk by avoiding overexposure to assets that have appreciated significantly, which may be riskier at that point. By ensuring that the portfolio remains diversified and adheres to the predefined risk tolerance, rebalancing effectively controls the risk profile, maintaining stability over time, especially during volatile market conditions.

The nature of rebalancing often means that investors are systematically buying low and selling high, aligning the portfolio with the investor's intended risk-return profile. While rebalancing can incur transaction costs, it serves primarily to manage risk, promoting a balanced approach that shields the portfolio from excessive risk due to concentration in certain assets or sectors.