Portfolio Rebalancing for Muslim Investors

Portfolio Rebalancing for Muslim Investors

Portfolio rebalancing is a crucial element of money management for Muslim investors too. Rebalancing your portfolio entails purchasing and selling positions in order to return to your original asset allocation. When one asset class beats another, your portfolio drifts from its initial investment mix. This is critical because unless you rebalance on a regular basis, you may be taking on more risk than you realize.

What is Portfolio Rebalancing?

Simply put, rebalancing is the process of returning your portfolio to its original allocation. If we put you in a 60/40 portfolio, which consists of 60% stocks and 40% bonds, the allocation may not stay exactly 60/40 for long as the market fluctuates. Stocks have historically outperformed bonds over the long run, so your allocation would gradually shift to be substantially stronger in stocks more than 60%.

Small changes in the 60/40 allocation may not seem substantial, but over time, an investment portfolio’s balance can get dramatically out of balance.

Note: Conventional bonds are impermissible for Muslim investors to invest in.

How Often You Should Rebalance Your Portfolio?

Although there is no set timeline for rebalancing a portfolio, most experts say doing it at least once a year. It is possible to spend a long time without rebalancing a portfolio, but this is typically not a good idea. Rebalancing allows investors to sell high and buy cheap, allowing them to reinvest gains from high-performing assets in sectors that have not yet seen significant development.

Rebalancing Strategies

There are two main rebalancing strategies: time-based rebalancing and tolerance-based rebalancing.

Time-based rebalancing simply implies rebalancing at a specific time interval. For example, you may rebalance your portfolio on December 1st of each year. This is referred to as rebalancing on a yearly basis. You might also do it on a more regular basis, such as quarterly. But the concept remains the same: arrange transactions on a regular basis.

The second option is to rebalance your portfolio only when it gets imbalanced to a specific extent. For example, the allocation of basic assets sets the portion of the stock at 60% of the total portfolio, while the remaining 40% is in the money market instruments. Then, after the stock market experienced an increase, the portion of the stock rose to 80% of the total portfolio, while the money market’s share fell to 20%. If this happens, you as an investor can sell some of your stock, then divert your investment to the money market investment whose portion has decreased so that the portfolio composition returns to 60% stocks and 40% money market.

Note: Investing in conventional money market instruments is not permissible for Muslim investors.

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