How to rebalance one asset class

Mark2016

Hi everyone. When I read articles about how to rebalance a portfolio it's always assumed that there is a mix of funds and bonds. Could someone tell me how to rebalance a portfolio if it consists only of funds. For example there are 8 funds and the initial investment for each was £2000. After one year one fund has increased by £900 whereas the remaining seven funds have each increased by £150. Does rebalancing mean that I would take a portion of the £900 increase and divide it and use it to 'top up' the remaining seven funds. I'm new to this concept of rebalancing and so would welcome advice. By the ways the scenario I presented is purely hypothetical. Many thanks.

bowlhead99

You have it exactly right. If your preference is to hold an equal share of each fund, then periodically you can sell out of the ones which are relatively larger and top up the ones which are relatively smaller.

This means that broadly you are going to stay equally exposed to all the sectors rather than having a majority of your money in that fund or funds which happen to have done particularly well (whether by luck or, generally, due to the particular economic circumstances you have just lived through). It has the useful side effect of selling funds which are above expectation and adding to those that are relatively cheaper.

If you never rebalance you could end up with your eggs in one basket. It is more pronounced if you have two or more asset classes which often don't move in a correlated fashion or have very different return characteristics (eg long term equities can be expected to perform much better than bonds but from year to year it could be one or the other on top). But still, it works the same way even if your holdings are all equities because eg US, Europe, UK, Asia, Emerging, small cap etc will all take turns to have their day in the sun.

Obviously you can change the example numbers to reflect your reality. You might have four funds in a ratio 100:200:200:500 and start with £1000. But then sometime later you end up with 150, 160, 250, 600. The total won't add up to £1000 any more because you have made some overall gains but you can still work out what "should" be in each for a given total value, if you intend 10%,20%,20%,50%.

Whether you actually need to do any selling of the biggest ones, or just buy relatively more of the ones which are below target, depends on how much new money you're putting in next year.

Mark2016

Thanks so much for your reply. I really appreciate it. In otherwords the fund that does exceptionally well just simply gets trimmed (not sold) and the proceeds to top up the lesser performers.

bowlhead99

Mark2016 wrote: »

Thanks so much for your reply. I really appreciate it. In otherwords the fund that does exceptionally well just simply gets trimmed (not sold) and the proceeds to top up the lesser performers.

Yes - you wouldn't expect to sell out of the good performer completely. Investments are a long term game. If it was sensible for you to have 10% in fund A this year and it has performed well, that's not a reason to sell it and have 0% in it next year.

But if it did well relatively to everything else this year then left unchecked you could be going into next year with 20% in that fund and a relatively smaller portion of your portfolio in everything else. That doesn't make sense in terms of spreading your risk, so you would sell some of it to get down to a reasonable level, like 10% again.

Mark2016

Thank you again. You've clarified this for me

coyrls

This all assumes that your original purchases conformed to an asset allocation model that you want to continue with. If there was no original model, it would be a good idea to create an appropriate one and then balance your allocations to conform to it. If your there was an original model but your circumstances have changed significantly or you think that the model need tuning, you may want to revisit your model before rebalancing.

TheShape

bowlhead99 wrote: »

Yes - you wouldn't expect to sell out of the good performer completely. Investments are a long term game. If it was sensible for you to have 10% in fund A this year and it has performed well, that's not a reason to sell it and have 0% in it next year.

But if it did well relatively to everything else this year then left unchecked you could be going into next year with 20% in that fund and a relatively smaller portion of your portfolio in everything else. That doesn't make sense in terms of spreading your risk, so you would sell some of it to get down to a reasonable level, like 10% again.

Is there a risk that if you're not careful, you could be selling out of a good performer and buying into a poor performer.

Does this only work if you have a very good spread of funds which are expected to perform differently at different points in the economic cycle?

bowlhead99

TheShape wrote: »

Does this only work if you have a very good spread of funds which are expected to perform differently at different points in the economic cycle?

Having a diversified portfolio is key, otherwise there is no substantial benefit from the diversification. If all funds were expected to perform well and badly at the same times as each other, there is little point in holding them. For example you don't need five separate UK equity income funds.

However, it would be quite valid to have a UK fund and a Japan fund and a US fund and a Europe fund and a developed Asiapacific ex-Japan fund and an emerging markets fund, even if they are all "equities funds"

It might be true that in a global boom or a global financial crisis, they will generally go in the same direction, ie up or down. However, if for example there is a new US President who decides to cut domestic tax on certain industries, create border tariffs on foreign goods, impose unilateral sanctions on certain regions of the world while stimulating domestic spending with borrowed money, that will have an effect on global exchange rates, corporate and government bond prices, US employment and consumer spending and inflation etc etc etc... And move US stock prices one way or another. And maybe move other global prices because investors know markets are often correlated. And likewise the opposite direction if/when it all goes wrong...

... but those specific events our actions will likely affect the US quite differently than they affect France or Indonesia.

Is there a risk that if you're not careful, you could be selling out of a good performer and buying into a poor performer.

Well, one school of thought would say don't have poor performers for your portfolio in the first place

You will have some that do better than others in different time periods, that's inevitable. If one does better than all the rest and you keep reinvesting the profits and your new money into that one instead of the other ones, you will concentrate your portfolio in that one asset; and after a while, you won't really have a "portfolio", you'll just have one main holding and a few token other bits and pieces.

With that one main holding, when you have a crash in that sector (and we know, you always have a crash in every sector in the end), you will suffer from a massive loss in a massive proportion of your portfolio, giving up a large proportion of your gains.

The result of the crash in that sector that you were deep into, is you going back to having your original money invested in a bunch of small funds, all of which have grown "a bit" rather than keeping hold of the gains that arose in the good times. You never kept your gains in any good performing fund because you just held until it collapsed.

By maintaining your target allocation you avoid overexposure and are naturally feeding the other funds which have not grown but have good *potential* to grow otherwise presumably they would not be in your portfolio at all.

bowlhead99

Also, goes without saying that if you're not convinced by usefulness of rebalancing in an equities-only portfolio, and want some real multi-decade data to back it up, you should check out the worked example in the old thread "the Power of the Rebalance".

It's how I got my little "post of the month" badge.

https://forums.moneysavingexpert.com/discussion/5208032

[Of course all my other posts on all manner of topics are awesome too, even if I am too modest to say so myself]

AnotherJoe

Mark2016 wrote: »

Thanks so much for your reply. I really appreciate it. In otherwords the fund that does exceptionally well just simply gets trimmed (not sold) and the proceeds to top up the lesser performers.

Just to add to the other posts, if this is a portfolio you are adding to on a regular basis, you might just top up the other funds, and stop topping up, rather than sel some of,the exceptionally performing one..