What does rebalancing a portfolio involve?

Rebalancing a portfolio fundamentally involves adjusting the proportions of different asset classes to maintain a desired risk profile and asset allocation strategy. Over time, due to varying performance levels, certain asset classes may take up a larger or smaller percentage of the total portfolio than originally intended. For instance, if equities perform exceptionally well, they might occupy a bigger share than planned, leading to increased risk.

By rebalancing, an investor sells a portion of the assets that have grown disproportionately and reallocates the funds to underperforming assets, thereby realigning the portfolio back to the original or target allocation. This process helps in controlling risk and ensures that the investment strategy continues to match the individual investor's financial goals and risk tolerance levels.

Other choices do not accurately capture the essence of rebalancing. Tracking market indices focuses on performance measurement rather than asset allocation management. Reducing losses in a declining market implies a reactive approach rather than a proactive strategy of maintaining portfolio alignment. Investing in foreign markets refers to a specific investment strategy that does not relate directly to the concept of adjusting asset class proportions within an existing portfolio.