Why younger investors should rebalance

It’s a common misperception that the greatest determinant of portfolio return variability is your stock selection.

Understandably, choosing which ETFs, individual shares, active funds or other securities to invest in is often the most exciting part of portfolio construction for new investors, and of course it remains an important factor.

But as Vanguard research shows, it’s your underlying asset allocation that most explains the fluctuations in your portfolio, and not which securities you’ve invested in nor when you did.

Because of this, your strategic asset allocation is your best weapon against market volatility and the best mitigator of market risk. Sticking to it by periodically rebalancing your portfolio is likely to give you the best chance of investment success.

Why younger investors should rebalance

But wait, what is rebalancing?

Rebalancing a portfolio simply means adjusting your investments to match the target asset allocation you first decided on.

The aim of rebalancing is not to maximise your portfolio returns, but to control how much risk you’re taking on. This is determined by how much of your portfolio you put towards each asset class (as each asset class entails different levels of risk).

Over time, your portfolio will begin to drift from your target asset allocation depending on how the market has performed. For example, a boom in equities is likely to mean the value of your shares has grown disproportionately to your other assets. Because a greater portion of your portfolio is now made up of shares, the level of risk you’re now taking on has also inadvertently increased.

Why is rebalancing sometimes overlooked by new or younger investors?

While the process of rebalancing can be quite simple, the actual decision to rebalance can sometimes be met with a mental block, particularly for those who started investing post COVID outbreak and haven’t yet experienced a significant market correction. After all, selling a well-performing asset and buying an investment with lower returns seems a little counterintuitive. If shares are doing so well, why would you want to sell?

The answer lies again in risk control. A bull run in equities cannot last forever (and we’ve already started to see share prices begin to taper off). If your portfolio is overweight in equities and inadequately diversified across different asset classes, it’s likely a sudden fall in shares will negatively impact your portfolio value more than usual.

Similarly, in bear markets, investors are thought to be more risk averse. This can lead to being underweight in equities or higher-risk assets for fear of further loss, and an unwillingness to rebalance into these asset classes even though your risk level has reduced to below what’s needed to generate sufficient returns. This may be particularly true for new or younger investors who might not have a lot of capital to invest and are therefore more protective of where they allocate funds.

Why should younger investors practice rebalancing?

Rebalancing instills discipline, which is perhaps the most important trait for all investors to have. The willpower to stick to an investment plan and strategic asset allocation no matter the market climate is the most effective way to achieve your financial goals.

By practicing rebalancing early on, younger investors can refine sound investment behaviours that will remain imperative throughout their entire investment journey.

How and when should investors rebalance their portfolios?

Most rebalancing strategies are either based on a time trigger, a threshold trigger or a combination of both.

With a time-based strategy, the portfolio is rebalanced on a predetermined schedule such as quarterly, semi-annually or annually (but not daily or weekly).

With a threshold-based strategy, the portfolio is rebalanced only when its asset allocation has drifted from the target by a predetermined percentage, such as 5 or 10 per cent.

Investors can also rebalance by:

1. Reinvesting dividends. Direct dividends and/or capital gains distributions from the asset class that exceeds its target into an asset class that is underweight.

2. Making additional contributions. Add funds to the asset class that falls below its target percentage.

3. Transferring funds between asset classes. Shift money out of the asset class that exceeds its target into the other investments.

For more information on how to rebalance your portfolio, see here. Alternatively, you can contact us on 03 9553 0271 to discuss in more detail. 

Source: Vanguard February 2022

Reproduced with permission of Vanguard Investments Australia Ltd

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

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Authorised Representative 298494
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 .

I have been through many of the strategies I talk with clients about myself and with my family.

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.

I am committed to understanding your needs and identifying strategies and products to help you achieve your goals.

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.

My experience is complemented by professional qualifications including:

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At Choice Financial Advice we work with you along the way on life’s journey.

Whether you are getting married, starting a family, embarking on the trip of a lifetime, planning to enjoy your years after work or assisting elderly parents with Aged Care and Nursing Home placements, we can help.