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.

What is portfolio rebalancing

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 03 9553 0271.

Source: Vanguard

Reproduced with permission of Vanguard Investments Australia Ltd

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Interprac Financial Planning Pty Ltd 

Darryl Jopling

Senior Adviser

I have worked in the financial services industry since 1982 and as a Financial Adviser since 1999.

I have worked for large Financial Planning businesses, Membership based organisations and looked after the financial planning needs of clients within an Accounting Practice before starting my own business.

I am married, have 4 older children and a grandson and I am keen golfer with mixed results like many .

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I have been through the journey of seeing my parents move into Aged care and negotiated the difficulties and pitfalls of understanding the system for them and this gives me an excellent insight into what is required to assist families at this difficult time.

In a previous roll I used to run retirement seminars looking at Centrelink and Retirement Incomes and how to make these work for you. I have helped many of my clients with Aged Care advice when their parents needed to move into Nursing Homes. For many clients I assist them with superannuation, building wealth and protecting their loved ones with insurance.

I am supported by his, Licensee, Interprac Financial Planning’s in-house resources and ongoing technical, systems and training.

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My guiding principle as an Adviser is to design plans which help to provide my clients with clarity of purpose and the opportunity to build a solid financial foundation.
I will take the time to listen, explain things clearly and keep you informed throughout the advice process.

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