Rebalancing based on threshold deviations examines how far each individual asset has deviated from their target allocations. In the example illustrated above, we have selected to evenly distribute our allocations among 5 different assets. These 5 assets therefore each hold 20% of the entire value of the portfolio when we initially allocate the portfolio. Over time, we find the portfolio allocations for each asset deviate from their target allocation.
In order to prevent excessive deviation, we selected a max threshold of 15%. Once an asset diverges from their target allocation by more than 15%, a rebalance will be triggered. Trades will then be executed to once again reach the desired percent allocation for each asset.
Notice the threshold is a deviation from the desired allocation. It is not an absolute percent change. That means our assets don’t need to consume 15% more of the portfolio to become 35% of the total portfolio value. Each asset only needs to consume or lose 15% of their target allocation to trigger a rebalance.
The reason threshold rebalances are executed in this way is because diverse portfolios won’t be able to provide the necessary movement to trigger rebalances if the percentages were absolute. Imagine having a portfolio of 100 assets. If each of these assets holds 1% of the total portfolio value, it would be exceptionally rare to execute a rebalance even with a 1% absolute threshold.
Additionally, distributions of assets can be flexible. Not everyone is looking for even allocations. It’s possible to see a portfolio of 99% in a single asset. To provide consistency on when rebalances are executed, a relative percentage is used for threshold calculations.Threshold Rebalancing in Shrimpy
In the Shrimpy Application, threshold rebalancing is a strategy which can be implemented by users to control for risk. Automating your portfolio has never been easier. In seconds, implement a dynamic cryptocurrency index...