No financial adviser can stress enough that it is unwise to expect your portfolio, however carefully put together, to fulfil your investment goals automatically over the long term. Periodically reviewing the assets you hold is vital if you don’t want to fall victim to portfolio drift. “Rebalancing instills good investment habits, trimming the holdings that have done well and topping up those which have done less well to bring your portfolio back to its original allocation,” explains Hargreaves Lansdown’s Danny Cox.
But what are some of the most important things to bear in mind if you’re rebalancing your portfolio? City A.M. speaks to the experts.
A 2010 report by Vanguard deemed asset allocation to be “the most important decision in the portfolio-construction process,” taking into account an investor’s risk tolerance, time horizon and financial goals. A portfolio that is unbalanced could well be exposing you to more – or less – risk than you originally intended, and that will affect your returns. Differing levels of growth between investments mean that your asset allocation will vary over time, changing the risk profile of your portfolio, says Cox. He gives an example from 2014: “property has had a good year, whereas smaller UK companies have been generally flat.”
Because asset classes don’t move in tandem, a diversified portfolio is key to achieving the right mix of risk and rewards. Having assets that perform differently at the same time is vital, says Cox, as it “helps reduce risk and provide more consistent returns.” Maike Currie of Fidelity Personal Investing hammers home the point: “whether you opt for active or passive funds, or how much you invest, pale into insignificance compared to the importance of achieving the right balance of cash, fixed income and equities in your portfolio.”
And the more wide-ranging your asset allocation, the more independent your assets are of one another when it comes to the impact of market events or economic cycles, adds Jason Hollands of TilneyBestinvest. In fact, in a volatile market, a wide array of assets can help ensure additional portfolio returns: profits can be taken from asset spikes and reinvested in deeper falls, says Cox.
But it is important to remember that asset allocation isn’t a silver bullet when it comes to preventing loss, says Shaun Port of Nutmeg – it’s just “the best way to spread risk, deal with uncertainty, and have a smoother ride.”
THE HANDS OF TIME
Another pivotal element to bear in mind is time – when should you rebalance? A managed portfolio will typically be rebalanced quarterly. If you’re managing your investments yourself, Hollands recommends rebalancing “at least once annually,” while Currie suggests every sixth months. But this will depend on whether you’re adopting an active or passive investment style.
The investment wrapper you choose will also make a difference to timing. If you tend to invest in Isas and Sipps at the end of the tax year, between now and the end of January is a good time to review how under or over-exposed your portfolio is, says Hollands. He also suggests rebalancing when you’re investing new money – it might be that “any portfolio imbalances can be addressed wholly or partially through where new cash is directed.”
Port says a rough rule of thumb is to consider rebalancing if your asset mix is more than 5 per cent away from its long-term goal (say your allocation in stocks has drifted to 65 per cent, when your long-term goal was 60 per cent). But even with that in mind, “it is imperative that the benefits of doing it don’t outweigh the costs.”
CLOCKING UP COSTS
Indeed, transaction costs should be a key consideration, especially if you’re using an online platform, says Hollands. That said, trading funds on a platform is often free, and if you are disciplined about when and why you rebalance, costs shouldn’t be a problem.
But if you own shares, ETFs and investment trusts, and you’re not using a tax shelter like an Isa or a Sipp to hold your investments, you will need to bear in mind capital gains tax when you rebalance. Thomas Diaper of Plutus Wealth Management points out, however, that “very few people actually use their £10,800 of capital gains tax allowance consistently each year” – if your profits fall within that allowance, annually rebalancing isn’t going to be a problem. Moreover, it makes sense, he says, to use your yearly allowance, rather than store up gains and losses and then have to surrender them in a single year.