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Your investment portfolio: when was the last time you rebalanced it?

One of the key themes you hear as an investor is the importance of building a balanced, diversified portfolio. Here we explain why this is important, how it can often come under strain – particularly during tough economic times – and what you can do to rebalance your portfolio if needed.

Published on 30 Nov 20227 minute read

Written by David Craik

It makes sense as investors to have a diversified and balanced portfolio. It can look after your invested cash in both sunny economic times and bad. But like a gymnast on a beam, that balance can be lost easily.

What does a balanced portfolio mean?

It means making sure that you aren’t just invested in one type of asset, but have a ‘pick and mix’ style selection.

This is usually a combination of stocks and bonds, such as 60% of your cash invested in one and 40% in the other, but can also feature other assets such as gold or real estate.

It also means diversification across industry sectors, geographic regions, and investment style.

This balanced, diversified approach protects you from the ‘eggs in one basket’ scenario, where if you are 100% invested in stocks and the market crashes then the value of your portfolio will also plummet. In a diversified portfolio, because assets tend to perform differently, if stock prices do fall then typically another of your assets such as gold will maintain or increase in value – although this isn’t guaranteed. You might not get all the highs of the stockmarket, but you’ll generally escape some of the lows.

Watch out – your portfolio can lose its balance

After you’ve carefully constructed your balanced and diversified portfolio, it might be tempting to think that the hard work is done. That all you have to do now is sit back and enjoy all those lovely, diversified returns.

Well, life is never that simple – especially when investing in the volatile world of stock markets.

Fluctuating prices have an impact

Share prices naturally fluctuate from minute to minute as companies and sectors go in or fall out of favour, because of customer demand, management change, new regulations, or geopolitical events.

Just say you have a particular percentage of your portfolio invested in US pharmaceutical stocks. A deadly new pandemic sweeps across the globe, prompting a rally in pharma share prices as they unveil lifesaving vaccines.

Great news for the world, but the price hike now means your portfolio is overweight in pharma stocks. The value of these stocks has become greater than the value of other parts of your portfolio. This leaves it less diversified and over-exposed to a subsequent drop in pharma stocks.

Your emotions can play a part

Emotions, as well as events, can also upset your carefully calibrated balance. It is difficult to detach your emotions when investing in the stock market. Emotions often drive your decision to begin investing in the first place, from the worry over whether you will have enough money to enjoy your retirement or the excitement of building your wealth to go on a round-the-world trip or afford a private education.

As such investors can easily get drawn into the drama of stock markets, such as panicking during periods of great volatility and uncertainty and selling out of positions too soon. They can also be caught up in the buzz around a new stock or sector and buy without doing proper research and analysis.

Investors can also get carried away with their successes. This means staying invested in sectors that may accelerate during times of economic sunshine but tend to suffer in times of higher inflation and interest rates. Even though they know that the sector is in decline they retain their memories of the good times and can’t let go. A little like a person’s love of the Rolling Stones or Andy Murray.

As Ben Seager-Scott, who is Head of Multi-Asset Funds at Evelyn Partners Investment Management Services Limited and runs our Ready-made Portfolios, says:

“There are often periods where one particular sector or style has an especially strong run such as technology during the pandemic or energy in 2022, which is obviously beneficial for those with exposure. However, it can lead to disproportionately high weightings and a volatile ride, including the risk of more hair-raising short-term losses should the performance of those sectors return to average levels. An investor who knows what their portfolio should look like for the long term and keeps it rebalanced doesn’t have to worry about the day-to-day market mood.”

Risk appetites change

Investors may also want to change their portfolio to suit a change in their risk appetite or investment objectives. This could include a requirement for more income or a change in their retirement plans. Again, this will impact the overall portfolio balance.

It is vital therefore to keep monitoring and maintaining your portfolio. What you thought of as a balanced asset allocation when you set it up might not suit your lifestyle today.

How to rebalance your portfolio

Investors can either re-balance their portfolios at regular intervals, such as once every year, or when they sense or see that their portfolio has deviated too much. Here are some key steps:

  1. Consider selling your outperforming assets and using the proceeds to buy more assets from the underperforming parts of your portfolio. That could mean selling bonds and buying more stocks or vice-versa. The key is to restore the original asset weightings of your portfolio.
  2. If you want to leave winning assets alone, another approach is to allocate new cash to top up the underperforming assets to redress the balance in the portfolio. This is known as cashflow rebalancing.
  3. Weigh up the cost. There can be a financial cost to re-balancing, for example because of trading fees or potentially having to pay tax on capital gains for investments held outside ISAs and pensions. If your portfolio is only slightly out of line this cost may sometimes outweigh the benefit of rebalancing.
  4. Ensure that your re-balancing puts you back in line with you overall risk tolerance levels and investment goals. Control those emotions.
  5. Consider the market environment. It can be more complicated to construct a diversified and balanced portfolio during tumultuous events such as the financial crisis and the Covid pandemic. Unusual monetary policies from central banks like the Bank of England during the last decade or so have included driving interest rates to historically low levels and buying bonds through quantitative easing. This has distorted the performance of equities and bonds and made them more closely correlated.

The benefits of rebalancing your portfolio

Regular rebalancing ensures that your portfolio remains well diversified, matches your risk appetite, and maintains your desired level of targeted returns.

Another benefit of regular rebalancing is that it reinforces vital investing fundamentals.

“Ensuring that a portfolio has a balance at all times brings an important discipline to investing. It encourages investors to sell out when prices are high and reinvest when prices are low,” says Ben Seager-Scott. “While in theory it may be possible to time your exit from a particular sector – selling out when it looks like its fortunes are weakening – in practice, this is fiendishly difficult to do. Even professional investment managers who are monitoring the market day to day and have abundant information at their fingertips rarely attempt it. The market often anticipates change for individual companies and sectors ahead of time, which makes it tough to get ahead of it.”

It’s also good for your blood pressure and sanity. As Ben says, “An investor who knows what their portfolio should look like for the long term doesn’t have to worry about the day-to-day market mood. Those investors that maintain a diversified portfolio are more likely to have experienced a smoother ride over the long term.”

 

How Bestinvest can help you with your investment portfolio

At Bestinvest we have everything to help you make the most of your investments:

Important information

This article does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

The value of an investment, and any income from it, may go down as well as up and you may get back less than you originally invested.

Past performance is not a guide to future performance.

Prevailing tax rates and reliefs depend on individual circumstances and are subject to change.

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