Rebalancing is the practice of realigning the components of a portfolio of investments back to a target allocation from which it has drifted away. Naturally, the process is contrarian and results in selling the things that have done well and buying more of what has done less well. To some, this may feel painful, but it is good practice and sensible behaviour your adviser can certainly support you with.
Left un-rebalanced, a portfolio comprising 60% global equities (‘growth assets’) and 40% short-dated global bonds (‘defensive assets’) would have drifted to nearly 80% in growth assets over the past 10 years. This is a material change in risk exposure.
The figure above illustrates the primary need for rebalancing i.e., to prevent unwanted asset allocation drift. Evidence supports that this is the main role of rebalancing. It is a process which encourages good investor behaviour and helps one avoid falling foul of biases. Rebalancing helps systematic investors maintain a well-diversified solution through time, enabling them to benefit from exposures to imperfectly correlated assets.
Investors hoping to profit in the short term from rebalancing trades face certain long-run disappointment. … The fundamental purpose of rebalancing lies in controlling risk, not enhancing return.
In some cases, contributions to and withdrawals from your portfolio can be used to nudge the allocation towards the target to keep risk in line. Keeping a watch on how far your portfolio drifts from its target is something your adviser will help with. At times of market turmoil, the issue of a potential rebalance may be considered – in order to realign risk - and don’t be surprised if we raise this with you at such a time.
Do you really need to rebalance? The answer for most investors is likely to be ‘yes’ when the time comes. If we feel a rebalance is necessary, we will be in touch to discuss this with you.
