What is portfolio rebalancing?

Just like your car needs a periodic service to stay in tune, here’s why you should rebalance your portfolio from time to time.

A portfolio’s asset allocation reflects an investor’s goals and temperament—the need for return as well as the ability to withstand market turbulence.

Over time, market fluctuations can affect your asset allocation weightings and change the risk/return profile of your portfolio.

For example, say your target asset mix is a 50/50 split between shares and bonds. You originally invest $3,000 in a shares fund, which buys 20 units. You invest another $3,000 in a bond fund, which also buys 20 units. Your $6,000 portfolio balance is split evenly between stocks and bonds, matching your target.

Let’s say that over time your share fund units have consistently outperformed your bond fund units. For simplicity, let’s also say you don’t reinvest your dividends or capital gains or make any additional contributions, so you still own 20 units of each fund.

As a result of market fluctuations alone, your 20 share fund units are now valued at $5,000, and your 20 bond fund units are worth $2,000. Your total portfolio balance—$7,000—is now split approximately 70/30 between shares and bonds, making your portfolio overweight in shares.

This scenario may be profitable right now—after all, you have more money invested in the higher-performing asset class. So what’s the danger?

What goes up can come down. If you lose parity with your target asset mix by remaining more heavily invested in shares and they go down in value, you can have more to lose than you anticipated.

Rebalancing from one asset class to another (in this case, selling share fund units and buying bond fund units) can put your portfolio back on track and make sure you’re not taking on more risk than you are comfortable with.

Why should investors rebalance?

Selling a well-performing asset and buying an investment with lower returns may seem counterintuitive, but the objective of rebalancing is to manage risk rather than maximise return.

When investors select an asset allocation, they choose a mix of assets that is expected to produce returns that can help them meet their goals with a level of risk they can tolerate.

By periodically rebalancing, investors can diminish the tendency for portfolios to drift to a risk level that is inconsistent with their risk profile.

Rebalancing can also help with discipline and emotional control when markets are volatile.

A set policy will trigger rebalancing events in a consistent manner no matter which direction markets head, which means investors are less likely to make any rash decisions to buy or sell securities that may jeopardise their long-term investment goals.

Contact us today if you’d like to talk about your investment strategy. Call on 1300 854 764.

Source: Vanguard

Reproduced with permission of Vanguard Investments Australia Ltd

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

© 2022 Vanguard Investments Australia Ltd. All rights reserved.

Important:
Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business nor our Licensee takes any responsibility for any action or any service provided by the author. Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.