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Why returns fall off track without regular rebalancing

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Don’t be distracted by short-term volatility; always keep your long-term goals in mind. Regular rebalancing back to the asset allocation you have chosen ensures that the risk level and expected return of your portfolio remain appropriate.

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Having decided on and implemented the appropriate asset allocation given your risk and return targets, naturally, market movements will cause the actual allocation to stray from the target allocation over time.

Unless your target return and/or risk tolerance changes, the logical course of action would be to regularly bring the portfolio back in line with the target allocation. This practice is known as rebalancing and should be considered frequently, at least once a year.

Rebalancing can be done in different ways: by selling assets that are currently overweight and buying assets that are currently underweight with the proceeds; by putting more money in and buying only investments in the currently underweight asset classes; or if making regular contributions to the portfolio, directing more of these to investments in the underweight asset classes.

But if equities have been performing well and forced your equity allocation to drift higher whilst poorer performing asset classes are drifting below their target allocation, it would not be unusual for an investor to hesitate and ponder whether or not it is really the right time to sell some of the strong performing investments and buy more of the less well performing asset classes.

Although selling equities whilst they are rallying may cause you to miss out on part of the rally, having a rebalancing procedure in place should ensure that you sell high and buy low.

Staying focused
However, you should not lose sight of your long-term goals. Allowing the asset allocation to wander too far from the initial allocation decided upon would likely mean that the risk level and expected return of the portfolio are likewise drifting and no longer reflect those desired by the investor.

As such, it is wise to always keep the long-term strategy in mind, regularly review the portfolio allocation and rebalance accordingly.

As well as diversifying between asset classes, diversification within asset classes is also needed.

An investor can either define a frequency with which they will always assess the current status of the portfolio allocation, or alternatively, asset allocation ranges can be set. If, for example, the equity allocation range was defined as 40%–50% and equities rallied to such an extent that they reached 51% of the total portfolio, this would trigger a rebalancing back to 45%, the midpoint of the range.

It is also worth bearing in mind that although selling equities whilst they are rallying may cause you to miss out on part of the rally, having a rebalancing procedure in place should ensure that you sell high and buy low.

The aim is to build a portfolio of investments with the potential to achieve the desired return and a risk level that you are comfortable with. Ensure regular monitoring and rebalancing and modify your target asset allocation over time if appropriate.

Looking to the future
So in summary, investing is about growing your portfolio so that you have the funds required to meet your financial goals. The aim is to select a combination of investments that has the highest likelihood of enabling you to meet your financial goals.

The portfolio should not exceed the level of risk that you feel comfortable with, but investors should also be very mindful of the cost of underinvesting.

Stay disciplined when rebalancing
As well as diversifying between asset classes, diversification within asset classes is also needed. Investors should look to build up their portfolio with investments which are expected to perform differently from each other under any given market conditions.

In addition, it is vital to remain disciplined and regularly rebalance the portfolio in order to ensure that the asset allocation stays broadly in line with the defined target allocation.

Furthermore, as the time horizon diminishes over a period, the asset allocation should be modified accordingly. As the time horizon becomes shorter, adjustments should be made such that the risk taken gradually decreases.

If you would like to review your current portfolio, investment strategy or risk profile, your dedicated relationship manager will be happy to support you, both now and all the way along your investment journey.

How should you position your portfolio in the view of Julius Baer's experts?

> Contact us to find out