What does Rebalancing Really Mean?

Chris75

As part of a rethink of my investments started by a necessary platform change I have come to the tricky question of rebalancing. All the pundits say that it is important but what do they intend you to do?

I will say from the start that in my case historically this has tended to be rebalancing between funds but I am aware that the sort of funds that I hold has been changing as I have got older. I am now tending to invest in funds that have a much wider remit than funds that I held a few years ago. For example I now hold global funds whereas before I did not and those global funds change where they have money invested over time.

So do I rebalance between funds and ignore country bias, currency bias, capital size bias etc or do I dig into the funds & then look for what?

I am not expecting anyone to tell me the answer but I would appreciate knowing what others think. What do you rebalance?

AnotherJoe

To me rebalancing means changing the arbitrary allocation of your funds that you made at one time, to a different arbitrary allocation that you now prefer . (Or it can often mean moving back to the original allocation, though why people think the allocation they made at one time ought to remain constant over a lifetime is beyond me).

You can allocate across all the categories you mention plus many others. Which is where the arbitrary nature comes in.

Or you could just give up and move to global funds that do it all for you. I'm doing that gradually over time, same as you, migrating to those, but I do still own a lot of very specific things as well, from individual company shares to targeted and managed funds, obviously because i believe I can beat the market using those. I am astute enough to understand that I may be delusional in that respect though

dunstonh

When you build a portfolio of single sector funds, you initially invest it with x% in one fund, y% in another and so on. Over time, those allocations will go out of sync.

There are two models to rebalance those allocations. One is to revert to the original static allocation (that is a bit old fashioned now). The other is to rebalance to the latest allocations based on asset values, economic data and events. That is a better method as it is more "live".

If your portfolio does not have a defined structure then rebalancing doesnt matter as its random to begin with and it will still be random 6 months or 6 years later.

Professional allocations are structured with reason and analysis. Some of that may include assumptions and opinion but those will be documented. However, they are mainly built to meet a volatility rating and asset volatility ratings can change.

Failure to rebalance generally means the portfolio will become higher risk and more volatile the longer you leave it.

bowlhead99

AnotherJoe wrote: »

To me rebalancing means changing the arbitrary allocation of your funds that you made at one time, to a different arbitrary allocation that you now prefer . (Or it can often mean moving back to the original allocation

Moving back to an original defined allocation is what re-balancing is all about, to me.

Your portfolio went out of balance due to market movement (different investments move different directions and by different amounts at direct times). By "re" balancing it, you're bringing it back to the balance you previously had, which was suitable for your goals.

If you are now selecting "a different arbitrary allocation that you now prefer" which has different concentrations and different risk characteristics to the original balance that you liked, you are not really "'re" balancing it, you are just building some "new" balance of holdings, which you think is better than the original balance and better than what the original balance had moved to of its own accord.

though why people think the allocation they made at one time ought to remain constant over a lifetime is beyond me).

As dunstonh says, It probably ought not to remain constant over a lifetime, as firstly, your needs don't stay constant over a lifetime, and secondly, as markets evolve they may take on different characteristics of risk and volatility, most noticeably at different points in the economic cycle but sometimes just as things change over time.

However, broadly there are things that might be expected to be somewhat permanent characteristics about a type of asset. Equities have different legal and practical features to debt and real estate which result in different levels of return and different risks being taken on. Government bonds have a different profile to high yield corporate. Developed markets mega-cap consumer defensive growth equities have different levels of volatility to frontier markets smallcap.

If I start the year with 75% equities, 15% bonds and 10% real estate, that might be an allocation that suits my needs for years. However in practice, the three components move at a different pace, whether they are positively or negatively correlated with each other. You might find equities rises 20% over a year and real estate up 10% and bonds fall 5%.

On an original pot of £10000 you would have gone from £7500 / 1500 / £1000 to a value of £9000 / 1425 / 1100 which is £11,525; split is now 78.1% /12.4% / 9.5%.

If you had decided that 75% equities was fine and 15% bonds was fine you might not be happy with the new 78:12% ratio. The greater eggs in the equities basket may be a concentration that you feel is high risk. Some people might wait until their equities got up to 80% or 85% before going "hold on, this is pretty far out of whack, I should rebalance". Others would religiously adjust every 6, 12, or 18 months. If 15-20% bonds is right for your risk tolerance and your performance aspirations, you don't want to be down at only 10% bonds going into an equities crash.

So for most people I would expect the practice of re-balancing is about coming back to a predetermined planned balance, not building a new one each time based on a market view and a constantly changing assessment of their needs. Our needs don't change every year, that's why we can invest for decades at a time. Subject of course to dunston's comments about whether the original ratios or portfolio constituents are still broadly sensible given the risks and rewards they offer.

If you are on global funds with an active manager you can let them do the work within the fund, but you should still see what they are holding and how that fits in with the other things you hold. For example you can still reallocate between your global strategic bond and your global equity income and your global cheap core tracker.

Each time you rebalance back to the target allocations you're comfortable with, you are implicitly "selling high" the ones that rose, to "buy low" the ones that have relatively underperformed. You can do this by actively selling and buying, or simply by putting your annual new money into the lower ones to bring them up to the right pro rata level.

As different sectors are expected to have different long term returns, you will find that even if everything performs "as you expected" (e.g. Equity 7% property 5% bonds 2%), after a while you will have more equity than planned when looking at a pie-chart of your holdings. So a regular rebalance is useful.

bigfreddiel

dunstonh wrote: »

When you build a portfolio of single sector funds, you initially invest it with x% in one fund, y% in another and so on. Over time, those allocations will go out of sync.

There are two models to rebalance those allocations. One is to revert to the original static allocation (that is a bit old fashioned now). The other is to rebalance to the latest allocations based on asset values, economic data and events. That is a better method as it is more "live".

If your portfolio does not have a defined structure then rebalancing doesnt matter as its random to begin with and it will still be random 6 months or 6 years later.

Professional allocations are structured with reason and analysis. Some of that may include assumptions and opinion but those will be documented. However, they are mainly built to meet a volatility rating and asset volatility ratings can change.

Failure to rebalance generally means the portfolio will become higher risk and more volatile the longer you leave it.

You don't need to be a professional of any sort to rebalance a portfolio. You just reset the percentage allocations to that at which you started. It's quite easy really, nothing too hard than some very basic arithmetic.

The difficult bit may be getting the initial allocations set to suit your objectives and attitude to risk, but again it's quite easy once you know how to correlate risk with assets.

Luckily there are lots of places to learn the theory, and it's quite simple and logical.

You have just as much chance of being successful as anyone else.

Good luck fj

dunstonh

You don't need to be a professional of any sort to rebalance a portfolio. You just reset the percentage allocations to that at which you started. It's quite easy really, nothing too hard than some very basic arithmetic.

You dont need to be a professional. However, if your initial allocations are not based on any data, analysis or research and are just random figures plucked out of thin air e.g. 10% in that one, 20% in that one, 5% in that one. Then it really doesnt matter too much if you rebalance as whatever the funds do, they will still be unstructured whether rebalanced or left alone.

Freecall

dunstonh wrote: »

You dont need to be a professional. However, if your initial allocations are not based on any data, analysis or research and are just random figures plucked out of thin air e.g. 10% in that one, 20% in that one, 5% in that one. Then it really doesnt matter too much if you rebalance as whatever the funds do, they will still be unstructured whether rebalanced or left alone.

Or to put it another way, you can't re-balance if you weren't balanced in the first place.

bowlhead99

bigfreddiel wrote: »

You don't need to be a professional of any sort to rebalance a portfolio. You just reset the percentage allocations to that at which you started. It's quite easy really, nothing too hard than some very basic arithmetic.

That is certainly true.

If you know the ratios you want to get back to, it's quite easy to say, ok I have £9000 / £1425 and £1100 in the three areas, plus £5000 fresh new money, I want the total pot to go back to my favoured split of 75:15:10:0, what should I buy and sell? That is a homework question I could give to my 10-yr old nephew.

As you say, the difficult bit is deciding that 75:15:10:0 is appropriate for your needs.

You have just as much chance of being successful as anyone else.

I don't agree with that.

Someone who researches his options in great detail and builds an asset allocation that doesn't put all eggs into one basket, has weighted the portfolio constituents so that the blended track record of volatility is something that he can tolerate, and the market risks and currency risks etc have been properly scoped and understood...

...is *much* more likely to succeed in his endeavours and get a result he's broadly happy with, than someone who doesn't bother with any of that because he can't be bothered reading more than a paragraph of text on the fund platform website and was told he had just as much chance as being successful as anyone else.

Nobody knows what bag of assets will go up the most. But people can select assets that are more likely to give them the result they need than if they'd built the portfolio by picking haphazardly.

For example, if you stick a pin in the dartboard and it says "stay in cash", you are incredibly less likely to grow your wealth in real terms than someone who is 80:20 global largecap: corporate bonds. Similarly, fashion investing by going all into oil and biotech could lose you 70% and then after rebalancing to a more sensible mix you would need to wait for 230% of gains to recover from the idiocy, while Captain Sensible had only lost 20% and was right as rain within 18 months.

Ray_Singh-Blue

Chris75 wrote: »

So do I rebalance between funds and ignore country bias, currency bias, capital size bias etc or do I dig into the funds & then look for what?

If you have a written investment strategy statement which specifies exactly what mix you seek, then rebalancing is quite straightforward. Basically just sell or buy stuff to make the mix reflect your target.

Chris75 wrote: »

I am not expecting anyone to tell me the answer

Sir, I hope I have exceeded your expectations

Chris75 wrote: »

What do you rebalance?

30% global equity tracker, 30% managed funds and individual shares, 20% fixed income, 20% commodities. Accumulation phase. New investments are made with reference to target asset allocation. Once per year in April formally rebalance if one sector is out by +/- 5%

Chris75

I am beginning to think that most peoples rebalancing is as unscientific as mine! I have always found it hard to sell something that has done well to buy more of something that has done not so well. I know that past performance etc etc but the financial press concentrates on little else often adding only subjective puff and concealed advertising. I also know that my original allocation was very subjective and any changes are probably just as bad.

I have been coming to the conclusion that I am better leaving the decisions to somebody else but when I look at the poor showing of many fund managers relative to indexes, even with the survivor benefit, I am not sure who. Cannot use past performance of course. :rotfl:

I also have a problem with concentration of funds. When I had a couple for the Uk, a couple for Europe, a couple for N America etc I had a reasonable number of funds in my portfolio. As soon as you start looking at Global Funds to remove the complications of deciding where to invest and in what proportions you end up with very few. I used to have 15 equity funds but I don't think anybody would recommend that many global funds. I can rebalance to just 4 global funds/ trusts but I am sure that for retirement monies that would be disapproved of as well. Having said that it has always been said that having too many funds doing the same thing is equally bad so going much above 4 would be undesirable as well . I also find it very hard to believe that if one of my 4 global funds did well it would be a good idea to sell it to buy more of the 3 that did less well. I can see that concentration is going to be a major problem.

PS Just to tell the tracker addicts that there is one in the 4 global funds above. I am however not convinced that one global tracker is the answer to the problems of the equity world.

Rebalancing / reallocating sounds so simple.