Rebalancing 'for dummies'

Judwin

Hi - I'm the dummy, trying to get my head around the idea of rebalancing. Lets suppose I'm looking to invest £10K this year in OEICS's, and my risk profile is 5 out of 10. I therefore go and buy £1K in ten different OEICS, one each in the risk grade from 1/10 to 10/10 .

OEIC1 - £1000 risk grade 1 - Cash under the matress Income fund
OEIC2 - £1000 risk grade 2
OEIC3 - £1000 risk grade 3
OEIC4 - £1000 risk grade 4
OEIC5 - £1000 risk grade 5
OEIC6 - £1000 risk grade 6
OEIC7 - £1000 risk grade 7
OEIC8 - £1000 risk grade 8
OEIC9 - £1000 risk grade 9
OEIC10 - £1000 risk grade 10 - Banana Republic Growth Fund

Total £10K spread around the world

A year passes, and all the investments grow in proportion to their risk grade, except the 10/10 Banana republic, where there was a military coup, and everything was nationalised, so I lost everything. So after a year, my portfolio is worth :

OEIC1 - £1100 risk grade 1 - Cash under the matress Income fund
OEIC2 - £1200 risk grade 2 - UK Other Bonds
OEIC3 - £1300 risk grade 3
OEIC4 - £1400 risk grade 4
OEIC5 - £1500 risk grade 5
OEIC6 - £1600 risk grade 6
OEIC7 - £1700 risk grade 7
OEIC8 - £1800 risk grade 8
OEIC9 - £1900 risk grade 9
OEIC10 - £0 risk grade 10 - Banana Republic Growth Fund

Total £13500 spread around the world except the Banana republic. So What Do I do to 'rebalance' ? Does it mean sell some of the higher performing OEICS to buy a bit more of the lower performing ones, such that I effectively have £1350 at each risk level? i.e.

Buy £250 OEIC1 - £1350 total
Buy £150 OEIC2 - £1350 total
Buy £50 OEIC3 - £1350 total
Sell £50 OEIC4 - £1350 total
Sell £150 OEIC5 - £1350 total
Sell £250 OEIC6 - £1350 total
Sell £350 OEIC7 - £1350 total
Sell £450 OEIC8 - £1350 total
Sell £550 OEIC9 - £1350 total
Buy OEIC11 - £1350 risk grade 10 - Cloud Cookoo Land Growth Fund

Is that what you mean by 'rebalancing'?

Cheers,
Judwin

dunstonh

rebalancing brings everything back to the % split you started with (or have moved to in case you have moved up or down the risk scale).

Your final table is the result you would expect after a rebalance.

In effect you are taking money out of what has gone up the most and putting it in to things which have either lost money or havent gone up as much. The idea being that what goes up comes down and what goes down comes up.

cheerfulcat

On the other hand you do run the risk of switching from what turns out to be a fantastic performer into an absolute dog. I wouldn't advocate " rebalancing " just for the sake of it. Yes, if one investment does twice as well as any of the rest there is something to be said for taking a profit and adding to some of the underperformers but I would be very cautious about buying more of the worst performer unless you know that it was so poor because of external events which are unlikely to be repeated.

dunstonh

rebalancing is about risk. If you dont rebalance, then over time your portfolio becomes riskier and when there is a downturn, it hits you harder than it would have done had you rebalanced.

Everybody picks the wrong fund from time to time. However, you dont pick just two funds and balance between the two. You are balancing the sector allocation and its at sector level where most of the return is.