Home Finance Wondering whether to rebalance your investments? Here are the factors investors should consider
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Wondering whether to rebalance your investments? Here are the factors investors should consider

by jcp
gawdo

By Alister Sneddon, Head of Product at CMC Invest

It’s news to no one that the financial markets have been through a period of significant turbulence. And rising interest rates and high uncertainty aren’t likely to change soon. As we slowly recover from political instability, some investors are reviewing their current portfolios.

What worked for you and your investments portfolio a year ago may no longer be suitable. And, given the current climate, it may be time to consider rebalancing your portfolio. Though rebalancing comes with risks and can be expensive, changing tactics could alter the fortune of your portfolio long into the future.

Understanding whether this will be for the better – or worse – in the context of your long term goals should be a crucial deciding factor in whether you choose to rebalance or not.

Why rebalance your investments?

Mixing uncorrelated asset classes is common practice for investors. Combining equity and bond splits will, in principle, spread the associated risk. For example, many perceive gold as a safe haven during times of high inflation. Layering that with a riskier investment will – theoretically – provide you with a trusted measure throughout market uncertainty.

However, when economic uncertainty hits the market, it can skew the balance you originally created, especially when it’s an economic downturn to a scale you hadn’t accounted for. Of course, this also all depends on an individual’s risk appetite; an investment allocation for one investor may be entirely unsuitable for another, and that’s okay.

To give an example, let’s consider an investor that started in 2022 with a heavy allocation to US high growth and momentum technology stocks and a small exposure to gilts and bonds. But now, as we begin 2023, the Nasdaq is down almost 30%. In comparison, the UK bond fund has suffered losses in the region of 6-10%. Suddenly, this investor has a different allocation to the split they decided in January 2022, with a skew towards gilts and bonds. Recognising your tolerance for this level of change is crucial in deciding whether to rebalance your investments.

Thinking tactically about your investments

To rebalance your portfolio, you need to review which assets have breached their allocations – and your tolerance – and increase or decrease investment to bring them back in line with your strategic vision. However, this is made harder by additional costs.

Many platforms and providers will charge a commission and FX fees for each sell and buy, and on top of this, you need to consider any government taxes, like stamp duty reserve tax on individual UK equities. Finally, the bid and ask spread will also create a small cost. Though small, it’s a cost all the same.

Assessing costs incurred may mean it makes more sense for you to stick to your original allocation and hold off on rebalancing. Rather than reacting to the economic climate today, some investors prefer to focus on the long term – ideally, this should be from five to 20 years in the future.

Should market instability drive you to move away from your original vision, or if you have a major life event to consider – for example, retirement – you may decide it’s time to make a tactical decision and change plans.

However, such adjustments may incur a significant cost impact. Chances are, you will have to reshuffle multiple investments and assets, and the costs of this will reduce the end value of rebalancing. In the long run, this can result in investors holding onto the tactical rebalance for longer than intended before deviating back to the original strategic model.

What to consider when rebalancing investments

It’s not just market instability that can prompt thoughts about rebalancing investments. Perhaps your risk appetite has changed, or you feel there are new opportunities yet to be explored. It is most important to remember that every ‘thought’ should not be instantaneously acted upon and there are several aspects to consider carefully ahead of embarking on a change:

  • Additional fees – costs, as discussed, must be a consideration. The total fees can significantly reduce the benefit of switching tactics, so you should weigh up whether a suboptimal allocation will ultimately align with your long-term goals versus the short-term desire to reactively rebalance investments in the ‘heat of the moment’.
  • Tax wrapper – is an account that protects your investment gains from tax, such as an ISA (Individual Savings Account) or Pension – if kept within the ‘wrapper’. Keeping your investment within an ISA or SIPP (self-invested personal pension) means you can remove the complexity around capital gains, while dividend tax income is also tax-free (aside from international withholding taxes). So, if you’re planning to rebalance, consider whether you can move the gains made from your portfolio into a wrapper to generate more wealth.
  • Cutting losses – it’s never easy deciding when to cut losses, take profits, or move on. Rather than letting your top-performing assets diminish over time, deciding -without emotional influence- to recycle your profits into another investment, such as a tax wrapper, will help generate wealth growth in the long term. Rebalancing your investments in this way can also help remove the emotional attachment to individual asset performance. Alternatively, if an investor believes in one asset, you can use its gains to invest more and restore its original weighting.
  • Bed & ISA / Bed & SIPP – If you are using a combination of tax wrappers to dictate your total allocation you can also opt for a Bed & ISA or Bed & SIPP towards the end of the tax year. Defined as selling investments outside of your ISA to then buy within your ISA, the process means you can repurpose underperforming assets. If choosing this technique, assess your long-term view of the investments before proceeding – as you always should be.

Finding another solution

Rebalancing your investments is a disruptive, time-consuming, and potentially money-intensive process. For many, avoiding it may be the better option in the long term, despite the short-term discomfort. Yet, choosing not to rebalance doesn’t mean there is no other action to take.

1. Investment style

Though some have one lump sum of money invested that they diligently manage over the years, most will invest regularly, topping up their portfolios each month. If this is you, your monthly top-ups can help rebalance your portfolio – without actually rebalancing. Consider adjusting your allocation to organically restore investments that have lost their original weighting. For example, if bonds are underperforming against equities, allocate new funds to favour bonds – over time, you will chip away at the imbalance.

2. Strategic investments

Similarly, you can make strategic adjustments over time to avoid selling down assets. Instead, you can divert new funds away and let that asset allocation remain as it is – preventing it from skewing your strategic balance. This technique is generally only temporary but buys time to consider your next move and avoids your portfolio weighting changing.

3. Satellite portfolios

A satellite portfolio, which is an allocation within an investor’s overall plan designed to allow tactical decisions, can give space for short-term risks that align with your long-term goals. While investors typically adopt a 40/60 split of equities and bonds, introducing a 50/30/20 split, in which 20% is available for short-term strategies, can contribute to your long-term goal while reducing the risk associated with rebalancing, for instance.

So, should you rebalance?

Your portfolio probably looks very different to how it did at the start of the year. But so will the majority of portfolios. Market turbulence does not discriminate: everyone with investments will be affected in one way or another.

Before making drastic decisions, step back and consider your ultimate strategic plan. Are you investing for the long-term or short-term? When do you want, or need, to cash in your gains? What level of risk can you financially support? What is driving you to rebalance – immediate impact, emotional reaction, or because the investment is no longer representing your long-term view?

Don’t make a hasty decision on a costly and time-intensive operation; instead, seek support and third-party advice if you need it. Navigating turbulent economics is never easy, but there are still gains to make. With a focus on your long-term goals and patience with every decision you make, you can get your portfolio to align with your long-term investment ambitions despite the current economic turbulence.

www.gawdo.com

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