Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
When I last looked at the performance of the various funds in my work pension fund, I was struck by how much better some had done than others. Once I’d got over the initial ‘what if’ reaction - why didn’t I put it all in the US? - I got to thinking about the tricky subject of rebalancing. What is it, how to do it and when?
If you have read more than a few of my articles here and in the Telegraph, you will know that I am a big proponent of diversification. I don’t have a crystal ball, so I prefer to cover myself by putting my eggs in a variety of baskets. That is certainly reflected in my pension, which a few years ago I split ten ways, as follows: Europe, Japan, Asia-Pacific, US, Global, UK, a contrarian value fund (UK), a global income fund, bonds and cash.
Now with the benefit of hindsight, I may have chosen a slightly different balance but let’s not forget that no-one invests with knowledge of the future. For now, I’m going to assume that I’m still happy with the allocation I chose then and look at how it has changed over time and whether I should take steps to get back to the original weightings.
So how have the different investments done and how has that left the balance of my portfolio today? Well, unsurprisingly, the best performing investment has been the one focused on the US, closely followed by the global fund and then, in descending order of performance, Asia-Pacific, Europe, Income, Japan, Bonds, UK, UK value, and cash.
The difference in performance over the investment period (I last rebalanced about three years ago) ranges from plus 58% for the US fund to just plus 5% for the cash. Please remember past performance is not a reliable indicator of future returns.
Having started with equal weightings in each holding (10% each), I was actually surprised at how little the balances have altered. The different investments now account for between 8% of the portfolio and 12%, showing how a broad diversification can create a smoother ride for a portfolio and mean you need to tinker less with your investments.
For illustration, if I had invested half my fund in the US and half in cash over the same period, the balance would have moved from 50:50 to 60:40 in favour of the US. A big effective rebalancing.
So, what is the argument for rebalancing? The main reason is to manage risk. If you simply allow your portfolio to run, without reverting to your original allocations, you will by definition become progressively more exposed to the best performing assets. These may have become more highly valued than the rest of the portfolio over time and be vulnerable to a correction. That is certainly a consideration today when parts of the US market (technology stocks, in particular) have done so much better than other investments.
By selling some of the best-performing funds and topping up on the less well-performing ones you open up the possibility that you will benefit from any catching up by the laggards. But a word of warning. This is not necessarily what will happen in the short run, and an argument can also be made for running your winners. You should be aware that rebalancing is actually the opposite of this momentum approach.
The question of how to rebalance, if you choose to, is a simple one of arithmetic. You need to sell enough of the outperformers and redirect the proceeds into the underperformers to bring the balance back to your initial allocation, if that is where you want to get to.
The last consideration then is how often to rebalance. There are no hard and fast rules here and it’s worth pointing out that my inertia has acted in my favour. By leaving my pension fund alone I have benefited from a bigger exposure to the best-performing assets which have continued to do well. Equally, they might not have done, in which case I would have regretted not rebalancing earlier.
I would say that a well-diversified portfolio does not need to be looked at more than once a year. As we have seen with my real-life example, even leaving the job for much longer than this has not made a huge difference. There might be a cost in switching between funds (although in my case fortunately there is not).
What else should you consider when deciding whether to rebalance? The purpose of reviewing your portfolio is to ensure that your investments are working as you wish them to - in terms of risk, geographic diversification, outcome (the balance between growth and income) and timescale (are you young enough to ride the ups and downs of the market or do you want a smoother ride, perhaps closer to your planned retirement).
In the case of my portfolio, inaction has brought me to a balance that I am reasonably happy with. As you will know if you have read my recent Investment Outlook, I am relaxed about having a slight overweight to the out of favour UK market at the moment, I don’t want to be over-exposed to bonds and, even after the recent outperformance, I’m happy to have a reasonable exposure to the US (including via the global funds).
Sometimes doing nothing is the right thing. I’m glad I checked, though.
Important Information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
Budget 2021: Who will pay for the pandemic recovery?
What should investors look out for in the Budget?
Pestilence and plague: Why Rentokil is placed to cash in
The pest control and hygiene products company shows there’s an upside to ever…
Why bond yields are rising and what it means for share prices
Inflation expectations at the heart