What is portfolio rebalancing and does it affect me?

An important investing concept you may be familiar with is diversification which you may understand as not putting all your eggs in one basket. One way to manage and ensure a diverse portfolio is maintained is through portfolio rebalancing. This article will provide you with a snapshot of what this means and the benefits it can provide investors.

What is rebalancing?

Portfolio rebalancing refers to the process of realigning the weightings of a portfolio of assets. This involves buying or selling particular assets over time to ensure that the desired percentage of asset classes or risk is maintained over time as the market fluctuates. The breakdown of particular assets within your portfolio, whether an investment or superannuation, will be contingent on the level of risk you wish to bear.

For example, if you are a growth-oriented investor you may wish to have 80% of your allocation in stocks or other equities and 20% in bonds or defensive assets. If markets perform in your favour the value of your growth assets will increase in line with this and therefore may further increase your exposure to these assets to 90% which may no longer align with your risk appetite. This would be remedied by rebalancing your portfolio and selling some of the equities you hold to lower your growth assets and ensure they remain in line with the parameters of your 80%G/20%D asset allocation. This is applicable to any investor, whether your asset allocation has a 50/50, 80/20 or 60/40 break down.

Why should I rebalance my portfolio?

The main reason why investors may wish to rebalance their portfolio is to ensure that the level of risk in their portfolio truly reflects the risk they are willing to take. This risk appetite will be dependent on how you approach risk and respond to market volatility. It will also be contingent on your investment timeframe, whereby you may be more willing to take on risk if you plan to grow your investment over a long-term period. Therefore, if you wish to have a highly-growth oriented portfolio that is associated with increased risk, portfolio rebalancing is a tool that can be used to ensure you are invested accordingly and are not missing out on market returns.

This will likely be different for a retiree or an investor who is nearing retirement and wishes to ensure they are not overexposed to growth assets. Thus, if the market performs well, it is likely to increase the value of the growth assets they do hold and therefore increase the risk in their portfolio. Failing to rebalance this prior to a market downturn may mean that investors in reality are more impacted by market volatility than their desired asset allocation.

When should I rebalance my portfolio?

There is no prescribed time for all investors to rebalance their portfolios, however, rebalancing at least once a year is a common benchmark followed by many investors. This could also occur on a quarterly, semi-annual or annual basis, as it provides a timeline that can be easily followed without requiring rigorous attention and rebalancing which incurs additional buy/sell spreads and brokerage fees.

How often investors choose to rebalance their portfolio will be dependent on their own time constraints and the money they are willing to spend on additional fees incurred when buying and selling particular assets. It will also be based on how far adrift, and investor is willing to go from their original asset allocation.

Another strategy for rebalancing is focused on placing parameters that allow for the asset allocation to shift within the specific bands. This is called a constant-mix strategy. Each individual security held within a portfolio is given a target weight and a specific range. This could include a breakdown of 30% of assets in emerging market equities, 30% in domestic blue chips and 40% in government bonds, in which the assets are able to fluctuate above or below a 5% range for each asset class.

What are the tax implications of rebalancing my portfolio?

As this process involves selling assets, it may incur additional tax implications such as capital gains tax, which will not receive the 50% discount if it is sold within 12 months of its purchase. However, these costs need to be offset against the risks of being too overexposed and the potential losses as a result of a market downturn or being underexposed and the results of missing out on market returns. To read more about capital gains tax, click here.

EPG Wealth clients receive a number of asset allocation checks throughout the financial year depending on which fee package they are on. Asset Allocations are a rebalancing strategy that involves ensuring that your actual allocation to different asset types in is line with your agreed risk profile. This is carried out periodically and helps to ensure that you are exposed to an appropriate level of risk whilst minimising the hassle of constantly checking and managing your own portfolio.

If you would like assistance with your current investment strategy or some further guidance on portfolio rebalancing, please click here to organise a complimentary 20-minute phone call with an EPG Wealth adviser.

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