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Does Rebalancing make any sense? - news article image

Does Rebalancing make any sense?

22 Jul 2015

2 minute read

By Ed Gibson, Head of Financial Services

Let’s start by being clear on what we are talking about…

Rebalancing an investment portfolio is where you have agreed a split between different asset classes, geographical areas and/or sectors as being likely to generate an acceptable level of return within an acceptable framework of investment risk. Then, on a regular basis, you sell part of a fund that has become larger than the agreed allocation and buy into a fund which has become smaller than the agreed allocation.

What you are aiming to do is to maintain that agreed allocation in order that you keep coming back to the mix which you believe will provide the acceptable level of return and stay within the acceptable framework of investment risk. If this mix was right when you started, unless what is acceptable in risk or returns has changed, then it should be right a year, three years or ten years down the line.

The problem is that this will therefore often mean selling from a fund which has done really well and may continue to do really well – so surely you are giving up on good performance? It also often means buying into a fund which has been falling and which may well continue to fall – so surely you are buying into a loss? You could alternatively view the former as taking profits before that market turns; or the latter as buying into a market which is due for a recovery.

However, these are not the reasons why you rebalance. All of these are based on a belief that you can tell what the future is going to bring; yet the only thing that the future is definitely going to bring is uncertainty.

The reason why you rebalance was demonstrated on a seminar I attended recently given by Vanguard, a major US investment company now making serious inroads into the UK. They compared what happened to a portfolio which started out split 60% equities and 40% fixed interest and left to its own devices, with a similar portfolio which was rebalanced once each year, from 1960 to 2013.

What was most noticeable was not that the average return was slightly higher for the portfolio that was rebalanced, but that over the period the portfolio that was allowed to drift was on average 77% invested in equities. Given that most of investment risk comes from the proportion that is held in equities, this meant that the risk was significantly greater. For someone happy to take that level of risk, if they had a portfolio with that level of equities in but rebalanced it, their returns would have been even higher.

So by letting the portfolio drift, you got not so much slightly less return than if you had rebalanced, but more importantly significantly less return than you were due for the risk you were taking.

If you require more information on rebalancing a portfolio, please contact Ed on 01865 292200 or email ed.gibson@shawgibbs.com.

Does Rebalancing make any sense? - news article image

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