Shadforth news

Striking the right balance with your investment

22 September, 2020

In this article we look at investment rebalancing, and how a structured and disciplined approach to rebalancing can ensure your portfolio remains appropriate to your circumstances.

For a well-rounded and happy existence, it’s important to maintain balance in all areas of life. Striking the right balance between the things you need to do versus the things you love to do, will ensure you’re well placed to achieve optimal performance. The same principle applies when it comes to your investments. 

As well as causing significant upheaval to our lives, the COVID-19 crisis has generated widespread turbulence in investment markets. A downward trend that began in February, culminated in what has already been dubbed ‘Black Thursday’ on March 12 - the worst one-day equity market crash since 1987.

Throughout the pandemic it’s been the higher risk growth assets, such as equities, that have taken the greatest hit on the global market. Safer defensive assets, such as bonds and other fixed income securities, have on the whole experienced little or no movement.

This market movement over the past few months means that the majority of investors would have experienced some deviation away from their target allocation of assets. The degree of movement would be dependent upon the weighting of their portfolio and their exposure to these riskier assets.

What is 'portfolio weighting'?

An individual’s appetite for risk is unique to them. The asset allocation decision – which takes into account your risk tolerance, time horizon and financial goals is the most important decision in the advice construction process.

Portfolio weighting describes the percentage of an investment in a portfolio – usually by asset class. For example, a typical balanced fund will have around a 60% weighting to growth assets and 40% weighting to defensive asset. A growth fund, on the other hand, may have a 70/30 weighting, also expressed as G70 (growth at 70%).

Within these weightings or target allocations, the investment policy document will also stipulate an asset allocation tolerance range. This range shows how far an asset can deviate from the target allocation before the asset allocation is out of balance.

Reweighting or rebalancing your investment portfolio regularly is a disciplined way of ensuring that you reduce the overall risk to your financial assets.

Why rebalancing is important.

Rebalancing can potentially enhance returns, but more importantly it is a risk-return measure. Even during normal trading conditions, different assets perform better or worse than others. These returns change your portfolio weightings which means your portfolio may no longer align to your chosen risk profile, potentially exposing you to more or less risk than you intended.

Rebalancing is the adjusting of portfolio holdings, that is, buying and selling certain assets in order to maintain your established Strategic Asset Allocation (SAA). Usually it means selling a portion of your portfolio that was outperforming and buying more of the underperforming asset. It is important to maintain your strategic asset allocation (via a rebalance) as it helps keep your tolerance for risk at the most comfortable level.

Besides market movement, another reason you may want to re-weight is that your risk profile has changed. As we get older and our circumstances change so does our tolerance for risk.

If you are 30 years old and planning 35 years ahead for retirement, you will probably be happy to accept greater risk, as short-term volatility can be tolerated in order to achieve your goals. On the other hand, if you are nearing retirement, you’ll probably not want to risk losing your money as you don’t have the luxury of time to recover from losses.

Rebalancing can also enhance returns

The graph below illustrates why rebalancing is so important and can help enhance returns.

Over time, portfolios which regularly rebalance are able to control risk better and provide better return characteristics than portfolios that do not rebalance.

The human behaviour factor

All too often investors do not apply a systematic approach to rebalancing. Instead our reaction when markets are going up is to buy and when they are going down it's to sell. Also, investors may trade too frequently which means taxes and transaction costs erode their returns.

That’s where professional advice comes in. Your adviser is there to assist you to take measured decisions to ensure your portfolio tracks to your overall goals and objectives. This gives you peace of mind knowing that your investments are being looked after by a team of investment and research professionals.

Applying a disciplined approach to rebalancing

Applying a disciplined approach balances both the frequency your investments are kept in line and the need to trade only where required to keep costs low.

Some of our platforms offer solutions that allow for Managed Discretionary Accounts (MDAs). In an MDA you delegate your authority to an Investment Manager to manage and rebalance your account in accordance with the terms of an investment program. This can enable speed of execution and less paperwork. They can be suitable for clients if you do not wish detailed day-to-day control over your investments and you like the approach set out in the investment program.

To find out more please speak to your financial adviser.