How to Rebalance and Adjust Your Crypto Portfolio

With the ever-changing crypto market and assets’ volatile nature, staying on top of your portfolio's composition is crucial for long-term success. That means you should regularly rebalance and adjust your portfolio, aka buying or selling assets to bring cryptos’ weights back in line with your target allocation.

In this comprehensive guide, we'll delve into the why, when, and how of rebalancing your crypto portfolio, along with real-world examples to illustrate key concepts.

What Is Portfolio Rebalancing

As the market fluctuates, the value of individual cryptocurrencies can change, which may cause your portfolio to deviate from its target allocation. With portfolio rebalancing, you realign the weight of each asset in your portfolio to maintain a desired risk and return level. It ensures that your investment strategy remains consistent with your investment goals and risk tolerance. 

Picture this scenario: You initially structured your portfolio with a distribution of 50% Bitcoin, 30% Ethereum, and 20% allocated to various altcoins. However, over several months, Bitcoin's value surged, swelling to 70% of your total portfolio, while Ethereum and altcoins maintained their relative proportions. Realigning your portfolio would mean selling a portion of your burgeoning Bitcoin holdings and reinvesting the proceeds into Ethereum and altcoins, thereby restoring the desired 50-30-20 ratio.

Why Should You Rebalance Your Crypto Portfolio

The reasons rebalancing is more than a nice-to-have include:

• Market volatility – prices can experience significant fluctuations within short time frames, leading to deviations from your target allocation.
   
• Changing fundamentals – fundamentals of individual cryptocurrencies can shift over time. New developments, partnerships, or regulatory changes may alter the outlook for certain assets.
   
• Portfolio diversification – your portfolio remains diversified, reducing overall risk. Over time, the performance of different assets may diverge, causing your portfolio to become skewed towards certain holdings.
   
• Risk management – you can mitigate concentration risk and avoid overexposure to particular assets or sectors, thus safeguarding your portfolio against potential downturns.
   
• Disciplined investing – encourages a systematic approach to buying low and selling high, which can enhance long-term returns.

How Often to Rebalance

The frequency of rebalancing depends on your investment strategy, risk tolerance, and market conditions. Some investors rebalance quarterly, while others prefer a more dynamic approach, adjusting their portfolios in response to significant market movements or changes in their investment thesis. 

Another rebalancing method is threshold-based, where adjustments occur when an asset's allocation deviates by a certain percentage from its target allocation. For instance, when the value of a cryptocurrency asset surpasses or drops below a predefined threshold, typically set at 5% or 10%, rebalancing is initiated to readjust it back to the designated target percentage.

Examples

Bitcoin Dominance

As Bitcoin dominance increases, dominating a larger share of the total cryptocurrency market capitalization, investors may consider rebalancing their portfolios to maintain exposure to other promising projects. For instance, if Bitcoin's dominance rises sharply, you might sell some Bitcoin and allocate funds to alternative assets like Ethereum or decentralized finance (DeFi) tokens.

Ethereum Upgrades

Ethereum's transition to Ethereum 2.0, a major upgrade aimed at improving scalability and sustainability, could impact its long-term prospects. Investors bullish on Ethereum may increase their allocation to capitalize on potential gains post-upgrade, while those concerned about execution risks may choose to reduce exposure until the transition is complete.

Altcoin Season

During altcoin seasons, when non-Bitcoin cryptocurrencies experience rapid price appreciation, rebalancing can help capture profits and reallocate gains to undervalued or more stable assets. For instance, if a particular altcoin in your portfolio experiences a significant price surge, you might sell a portion of your holdings and reinvest the proceeds into assets with more favorable risk-return profiles.

Steps in Rebalancing Your Portfolio

1. Assess your current allocation 

Begin by reviewing your portfolio's current composition and comparing it to your target allocation. Identify any deviations that warrant adjustment.

2. Set rebalancing thresholds 

Establish predetermined thresholds or criteria for rebalancing, such as percentage deviations from your target allocation or changes in market conditions.

3. Execute rebalancing trades 

Once you've identified assets for rebalancing, execute trades accordingly. Consider transaction costs, tax implications, and market liquidity when rebalancing your portfolio.

4. Monitor and iterate 

Continuously monitor your portfolio's performance and reassess your investment thesis in light of new information. Iterate your rebalancing strategy as needed to adapt to evolving market conditions and personal preferences.

Conclusion

Rebalancing and adjusting your crypto portfolio is a fundamental aspect of prudent portfolio management. Stick to regularly reviewing and realigning your asset allocation, so you can optimize risk-adjusted returns and maintain diversification. Additionally, stay disciplined, remain informed about market developments, and tailor your rebalancing strategy to align with your investment objectives.