rebalancing

markinsouthsea

I often in read in forums and the financial press that investors Rebalance. My question is what does that this really mean? and should I be doing it? I invest in a Sipp and have a number of funds that I drip money into on a monthly basis, I started the sipp about a year ago I think my highest performer is around 16% profit if I were to cash out now and the lowest is around 2%, all my funds are accumulation. The lowest performers tend to be the funds I have invested in recently so haven't had the length of time in the portfolio and the prices paid are post brexit vote when the markets have jumped.

Linton

When you set up your portfolio you do it on the basis of a defined asset balance. This could be in terms of geography, bonds vs equity, sectors or simply funds. Occasionally, say once a year, you sell and buy appropriate parts of your portfolio to reset the % allocation back to the original. In this way you are selling a few of the investments which have performed very well to buy more of the investments which are now cheap. Selling high and buying low is a good way to invest.

If you are drip feeding, to achieve a similar objective, you could each month put your money into the funds which are below the desired %.

Dont rebalance too frequently otherwise you will be trading on random price movements rather than longer term trends and incurring extra costs.

ischofie1

Rebalancing is effectively selling your funds and buying them back at the % you originally decided to allocate to each fund.

Let's say you had 5 funds @ 20% each to make up your portfolio. Let's say 2 funds went up 10% and the other 3 only 5%.
The 2 higher rising funds would now be worth more than 20% each and the 3 lower rising funds less than 20%.
Rebalancing would bring them all back to 20% each.

Yes you should rebalance. Either decide to do this over a set time, I.E. every 12 months or when funds become out of balance by a set % that you decide.

ex-pat_scot

Fundamentally, you ought to be setting your high level investment strategy, based on your risk appetite across:
- asset classes (bonds, equities, cash, property)
- geography (UK, Europe, US, Far East, emerging markets)
- commodities
- sectors.


As you note, the returns will diverge over time, meaning that the balance of your portfolio will become overweight in your better-performing assets.


#If# this becomes a problem for you (and frankly I would challenge whether any investment strategy has to be very tightly defined), then you would want to bring the overall asset mix back to your preferred set.


Be very cautious about how often you do this. I see professional wealth managers doing this on a quarterly basis for their investment portfolios: even through the 2008-2012 cycle they resisted the temptation to do it more frequently. I usually see individuals do this on an annual basis. The reason for caution is COST. Each sale & purchase will introduce frictional costs (dealing costs, stamp duty, possibly tax).


An alternative approach would be if you are still in accumulation phase, to divert more of your current new money into the "underweight" asset classes, so that you don't actually have to sell down (and hence avoid transaction costs). This also has the advantage of being a gradual rather than sudden rebalance, so further smoothing the impact of short term market movements.
If you are in decumulation, then the reverse would occur: liquidate your overweight assets, as you need the cash, until your desired asset mix is achieved.


I think the key principles still apply:


1. set and stick to an investment strategy. If in doubt, then this is the time to get professional advice.
2. monitor investment returns and portfolio balance on an annual basis, if possible. Don't fret the day-to-day volatility
3. rebalance infrequently, at minimal cost. Avoid having to sell & purchase, if at all possible.

dunstonh

I started the sipp about a year ago I think my highest performer is around 16% profit if I were to cash out now and the lowest is around 2%, all my funds are accumulation.

What investment strategy are you using?
What sector allocation data are you using?

12 months on, the allocations will be out of sync not only to the original allocations but also any changes in the allocations due to economic data updates and assumption changes. This means your portfolio will no longer be optimal and you rebalance to bring it back in line with what is optimal.

markinsouthsea

Thanks for the replies, I now see what rebalancing means. I don't really have a mathmatical split I have bought funds and added to them throughout the year. I have a mixture of funds and I'm sure if I were to list them I would be told that some overlap with each other as they invest in similar markets. I do have a tracker fund, bond funds and equity mixed funds worldwide funds U.K. Equity funds... I don't really have a strategy which says a percentage into each sector. I think all of the funds have a good record over the last 10 years which includes the mandatory bad year falls ...in my case as I want to enter drawdown and remain invested taking out around 4-5% of the value of the portfolio i will have to think how much of the portfolio is invested in the lower risk funds. I anticipate that in 5 years time I will draw around 5k per annum. After 7 years I will then have the state pension kick in which will then make my drawdown less critical and I anticipate that I may not need to drawdown regularly or maybe not even at all. However in life many things can change and the best laid plans can all change.

AnotherJoe

dunstonh wrote: »

What investment strategy are you using?
What sector allocation data are you using?

12 months on, the allocations will be out of sync not only to the original allocations but also any changes in the allocations due to economic data updates and assumption changes. This means your portfolio will no longer be optimal and you rebalance to bring it back in line with what is optimal.

Don't you mean, the OPs guess at what is optimal? No one knows except in retrospect what optimal is. So did you mean back in line with the OPs subjective and initial somewhat random guess ?

Also, whose to say the initial guess was correct ? Maybe the later allocation (arrived at randomly) is better, or shall we say, more "optimum" ? indeed, this is a problem with rebalancing it seems to me, there is an unwarranted assumption that having once decided on an allocation, that allocation should be set forever.

Seems to me more likely that allocations should vary over time, it's beyond implausible, with one exception, that any given allocation will be the right one indefinitely.

That exception would be, if you went for a global fund allocated across all geographies and sectors, where rebalancing occurs automatically as part if the fund.

ex-pat_scot

AnotherJoe wrote: »

Don't you mean, the OPs guess at what is optimal? No one knows except in retrospect what optimal is. So did you mean back in line with the OPs subjective and initial somewhat random guess ?

Also, whose to say the initial guess was correct ? Maybe the later allocation (arrived at randomly) is better, or shall we say, more "optimum" ? indeed, this is a problem with rebalancing it seems to me, there is an unwarranted assumption that having once decided on an allocation, that allocation should be set forever.

Seems to me more likely that allocations should vary over time, it's beyond implausible, with one exception, that any given allocation will be the right one indefinitely.

That exception would be, if you went for a global fund allocated across all geographies and sectors, where rebalancing occurs automatically as part if the fund.

That's why I start with "define your investment strategy".


- do you want to go down a "lifestyle" type approach - gradually derisking out of equities as you age?
- how much international exposure/ diversification do you want? (for example, I am very nervous with overreliance on UK; I would rather my portfolio be world-diversified with UK component roughly 5-10%)
- what assumptions are you making around the growth rates of each component of your portfolio, and do you understand & have the appetite for the risks in each asset class?


Until you consider these fundamental questions, then there's no point settting an arbitrary asset mix.
It doesn't have to be fixed over time; indeed the "Lifestyle" approach recognises a general de-risking plan to move gradually out of equities and into bonds as you age.


As an example, I find it hard to really see past a simple building block of global low cost ETF (VWRL Vanguard) as the core of my approach.

Linton

AnotherJoe wrote: »

.....

Seems to me more likely that allocations should vary over time, it's beyond implausible, with one exception, that any given allocation will be the right one indefinitely.

That exception would be, if you went for a global fund allocated across all geographies and sectors, where rebalancing occurs automatically as part if the fund.

There is no "right" allocation except in retrospect. Obviously if you could get it correct the "right" one is 100% those investments which will do well. However this is a little tricky to achieve in practice and a good second best is to diversify widely. Then rebalancing ensures that you are continually selling some, but not all, of investments with unusually high prices and buying more of those which are at unusually low prices whilst keeping a constant portfolio. Within reason, what the portfolios %s actually are is a secondary matter. This is likely to prove more successful than having a portfolio whose allocation varies greatly year to year as you try to catch the next big thing.

dunstonh

Don't you mean, the OPs guess at what is optimal? No one knows except in retrospect what optimal is. So did you mean back in line with the OPs subjective and initial somewhat random guess ?

Strategy should be based on analysis and data. No model can claim optimal overall but they can claim optimal based on the research and analysis.

Random allocations into a haphazard selection of funds will typically underperform an optimal portfolio built to the same volatility rating.

indeed, this is a problem with rebalancing it seems to me, there is an unwarranted assumption that having once decided on an allocation, that allocation should be set forever.

That assumes static rebalancing. I know the DIY models tend to be static but the actuaries on intermediary models run the data usually a number of times a year and adjust the allocations. So, in an IFA sense, rebalancing would normally include sector adjustments.

There are a number of actuaries that provide models and they are all different. Like any research and data analysis and varying assumptions, you get opinions and investing is all about opinion. However, structure and reasoning should exist with any model used.

Malthusian

One of the problems with automatic rebalancing is that by nature it means selling investments that have done well and buying more of the ones that have done badly. In the right conditions this can make sense as there's an element of selling high and buying low. But not always. For example, I wouldn't have minded being "overexposed" to the US stockmarket over the past 5-10 years. Conversely, if your portfolio involves actively managed funds then rebalancing will involve feeding more money to the dogs. I don't believe in star managers but I do believe that rubbish funds tend to stay rubbish.

I prefer to rebalance by adjusting the percentages for new money being added rather than selling existing holdings. There's less potential for regret.