Introduction:
You may find that your portfolio asset allocation has significantly deviated from your strategic or target allocation and, consequently, may not match your stated risk profile. Rebalancing your portfolio involves bringing your asset allocation back in line with your target or strategic asset allocation.
Understanding Strategic Asset Allocation:
Your strategic asset allocation is determined based on several factors, particularly your tolerance for the level of risk, which is measured by your risk profile. Generally, the higher your exposure to growth assets such as shares and property, the greater the level of risk in your portfolio. Your strategic asset allocation is structured to match your risk profile.
Why Rebalancing is Necessary:
As the investments and asset classes in your portfolio achieve different levels of returns over time, your actual asset allocation will drift away from the original strategic asset allocation. This may affect the allocation to growth assets in your portfolio relative to defensive assets. If the proportion of growth assets in your portfolio increases significantly relative to your target allocation, the expected long-term returns may increase, which is a positive outcome. However, it will also increase the risk in your portfolio, which may not align with your risk tolerance.
How to Rebalance Your Portfolio:
Rebalancing your portfolio involves adjusting your allocation to different assets to realign with your strategic asset allocation. This can be achieved in several ways:
- Selling and Buying Assets:
- Sell the assets that have increased their weighting and buy the assets that have reduced their weighting relative to your strategic asset allocation.
- Channelling New Funds:
- Direct any new funds or contributions to the assets that have a lower weighting relative to your strategic asset allocation to increase their weighting in your portfolio.
- Withdrawing Funds:
- Withdraw funds from the assets that have a higher weighting relative to your strategic asset allocation to reduce their weighting in your portfolio.
Regular Review:
Your portfolio asset allocation should be reviewed regularly (at least annually) to ensure that it has not unintentionally drifted away from the target allocation.
The Costs of Rebalancing:
Rebalancing your portfolio involves buying and selling investments, which can result in additional fees and costs, such as brokerage fees if buying and selling direct shares, and entry and exit fees in the case of managed funds. To minimize these transaction costs, it is recommended that you only rebalance your portfolio if it has drifted away from your strategic asset allocation by more than 5%.
Selling investments can also trigger a capital gains tax event, and you may be required to pay tax on the sale of your investments.
Conclusion:
Rebalancing is a crucial part of portfolio management that ensures your investments remain aligned with your risk tolerance and financial goals. By regularly reviewing and adjusting your asset allocation, you can maintain the desired risk-return profile of your portfolio and potentially enhance your long-term investment outcomes.
The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.
