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The importance of portfolio rebalancing

Date: 28/04/2022

To reduce risk and ensure your investment portfolio is fit for your needs, it is important to regularly review your asset weightings and adjust them as required.

Many people rightly take the view that they should invest for the long term and not respond in a kneejerk way to market ups and downs.

That is not to say, however, that you should just set and forget your investments. You also need to ensure your portfolio reflects your risk profile through a process known as rebalancing.

What is rebalancing?

When you first sit down with a financial adviser, one of the key discussion points will be around your risk profile. Are you a defensive investor? Or are you prepared to be more aggressive in the hope of generating higher returns?

This decision will be a major factor in determining your asset allocation and the level of risk that you can tolerate. Over time, market fluctuations can affect these allocation weightings – even if you have not actively changed the weightings yourself – and alter the risk-return profile of your portfolio.

That is where rebalancing comes to the fore. In essence, it involves periodically buying or selling assets to ensure your portfolio remains within the original target asset allocation. So, if one asset soars in value, or another one decreases, a financial adviser will more than likely suggest that you adjust your asset mix.

How does it work in practice?

As a simple example, let us say that your original target asset allocation was 60% shares and property versus 40% for bonds and cash.

However, at a later stage, the share market goes on a strong run and doubles in value over five years, while the bond market grows modestly over the same period. Such a scenario could quickly raise the shares and property weighting of your portfolio to 80% or more, meaning that your asset allocation is significantly out of balance compared with your original expectations.

With guidance from your financial adviser, you may as a result opt to sell some shares and buy some bonds to bring the balance of the portfolio back to 60:40. Doing so avoids the prospect of skewing your investments towards more of a growth portfolio.

Of course, it may sound counter-intuitive to sell a well-performing asset and buy an investment that is getting lower returns, but the goal with rebalancing is to manage risk rather than to maximise returns. This also allows you to pocket some gains and reinvest them in areas that are potentially on the verge of a growth phase.

Some investors will correctly point out that rebalancing may incur capital gains tax on any profits made on the sale of some strong-performing assets. However, sensible tax strategies may help minimise those gains and, if you fail to rebalance, you run the risk of being exposed to a market fall in another asset class that could be even more costly over the long term.

How often should investors rebalance?

While there are no hard and fast rules for the timing of a portfolio rebalancing, most financial advisers suggest examining allocations once or twice a year. At Adrians Private Wealth we incorporate this as a key element of your regular reviews.

Unless your portfolio’s value is extremely volatile, or if significant national or world events cause turbulence in markets, such rebalancing intervals should be more than adequate.

Some advisers may also recommend a managed fund, with one of the key advantages of such a fund being that they are actively re-examined and rebalanced on behalf of clients on a regular basis.

Should age influence asset allocations?

Changes in your life stage could also trigger a portfolio rebalancing.

Younger investors in an accumulation phase are likely to have a higher risk tolerance that favours an over-weighting in shares and property, while a person nearing retirement should probably consider higher asset allocations in defensive assets such as bonds and cash.

As always, different people will require different strategies and it is important to seek the advice of a trusted financial adviser before making any significant changes to your portfolio.

Regardless of your age, smart financial advice can make a big difference to your long-term wealth outcomes.

To find out more about managing your finances and  the benefits of rebalancing your portfolio, speak to one of our Adrians Private Wealth partners.