When it comes to successful investing, maintaining your share portfolio is at least as important as your initial investment decision. Regularly rebalancing your securities portfolio should form a key part of your investment strategy because it helps to ensure your portfolio remains aligned to your objectives, which in turn helps to ensure that you are positioned to meet your investment goals. However, many investors avoid rebalancing – much to their detriment!
What is portfolio rebalancing?
A portfolio’s risk and return characteristics are mainly determined by its asset allocation. Rebalancing is primarily aimed at minimising risk relative to a target asset allocation, rather than trying to maximise returns. However, investors often question the benefits of rebalancing, especially after periods of strong market growth. They find themselves wondering: “If my portfolio is doing so well, why do I need to rebalance?”
Preserve your portfolio’s risk characteristics
When we first help clients build their portfolios, we do so based on how much risk they want to take and their long-term investment goals. However, market movements over time result in the makeup of portfolios changing. Share performances differ relative to each other, and across sectors. Sometimes growth shares fare better and sometimes value shares outperform. Relative market performance changes your portfolio composition.
During times of strong market growth, you may be tempted to take on more risk in your portfolio. Conversely, the theory of loss aversion states that we hate losing money more than we like making it. When stock markets go down, and you see losses in your account, it’s tempting to react immediately and make changes.
Either doing nothing or making too many changes to your portfolio could therefore mean that it drifts away from its original asset allocation. This impacts both the risk profile of your portfolio and your ability to meet your investment goals.
Take a structured approach to your portfolio adjustments
Rebalancing is best approached in a structured and planned manner. Making wholesale changes is not advised. If the shares in your portfolio have performed well over time, you should smooth the switch into new shares in your portfolio. Unless you have a share in your portfolio that has not delivered on your investment needs, the generally accepted method for rebalancing your portfolio would be to adjust up to 25% of your portfolio on a quarterly basis.
If you sell a large portion of your shareholdings, you should also consider reinvesting part of the proceeds in fresh investments. This should be done based on your risk appetite, financial goals, investment horizon and investment objectives.
Take account of the big life events
It also makes sense to adjust your portfolio when your life circumstances change – whether it involves buying a property, getting married, changing jobs or having a child. This is especially true for investors who begin investing in shares at a young age, as they may initially take on more risk – especially if they enjoy some early successes. You also need to consider if your portfolio is aligned with your objectives in later life. Regardless of your starting point, however, when these life-changing events occur, it makes sense for all investors to review their accounts and ensure their portfolios are aligned to their financial goals.
Be disciplined about rebalancing your portfolio
The biggest enemies of rebalancing are complacency and overconfidence. To remain on track, you need to be vigilant about maintaining discipline. For example, although many investors are hesitant to rebalance when markets are at a high, it definitely makes sense to do so, as it allows you to realise profits when shares have risen sharply above the price you originally paid for them. Unfortunately, many investors become emotionally attached to shares that have done well, or conversely, can’t bear to sell out of a losing position and end up realising further losses.
The outside perspective of a qualified professional who is not as emotionally invested in your portfolio as you are, is invaluable when it comes to ensuring your portfolio remains aligned to your original investment goals.