An investor maintains a target strategic asset allocation of 50% Equity and 50% Debt. Following a massive stock market rally, the portfolio composition shifts to 65% Equity and 35% Debt. What disciplined action does portfolio rebalancing require?

[ A ]Selling a portion of equities and purchasing debt to restore the 50:50 target ratio[ CORRECT ]

[ B ]Increasing equity allocation further to 75% to chase rising stock momentum

[ C ]Redeeming all debt holdings and investing 100% in money market instruments

[ D ]Leaving the portfolio unchanged permanently because equity delivered higher returns

Takeaway

Option A is correct: Selling a portion of equities and purchasing debt to restore the 50:50 target ratio

Derivation

Portfolio rebalancing enforces discipline by selling an outperforming asset class that has exceeded its target weight and reinvesting the proceeds into underperforming assets, restoring the original 50:50 strategic allocation. This systematically forces the investor to 'buy low and sell high' without predicting market timing. This question tests the practical implementation of portfolio management. The primary pitfall is succumbing to recency bias by increasing exposure to the outperforming asset.

Why the others fail

B — Increasing equity allocation further to 75% to chase rising stock momentum

Expanding equity allocation to 75% magnifies portfolio risk and violates the client's agreed risk profile.

C — Redeeming all debt holdings and investing 100% in money market instruments

Liquidating debt entirely removes essential fixed-income stability and severely worsens the portfolio's asset allocation drift.

D — Leaving the portfolio unchanged permanently because equity delivered higher returns

Failing to rebalance leaves the investor with an unintended, elevated equity risk exposure during potential market corrections.