Over the last three years, we’ve seen stock markets deal with a pandemic, central bank and government intervention, sky-high inflation and a cost-of-living crisis.
Some investments will have done better than others, changing what your portfolio looks like. This is a good thing – your portfolio should be diversified so that different investments are exposed to different risks. But these moves can take you away from your original strategy.
When this happens, it’s important to check in on your investments and make sure you’re still on track. But, how do you do this?
Start with your strategy
Every investor should have a strategy. When setting up a portfolio, choosing the right strategy to meet your objectives and risk appetite is the first stage – the right balance between taking risk and seeking return. If your personal circumstances haven’t changed, the right place to start is by comparing your current portfolio to this strategy.
If circumstances have changed – like an inheritance or retirement – you should review this strategy and how much risk you’re happy taking.
How has your portfolio performed?
Without periodically checking in on how your investments are doing and then rebalancing, the best performing investments will become very large parts of your portfolio. And the worst will become very small. Rebalancing helps make sure your portfolio stays well diversified.
How and when you’ll need to rebalance your portfolio will depend on how it’s done and what’s done well.
In practice, this means you’ll be selling a portion of your strongest performing investments and topping up your worst performers. Over the very long term, this should help boost performance as you’ll typically be selling investments after they’ve become more expensive and buying cheaper ones.
But, as we‘ve seen with US technology stocks over the last decade, expensive investments can trend higher over many years. So, this won’t always be the case.
The old adage also tells us that ‘past performance is not a guide to future performance’. Even over five or ten years, the returns from investments are highly variable and hard to predict. As you should be investing for at least five years, short-term market movements shouldn’t necessarily trigger big knee-jerk reactions and a complete rethink of your strategy.
3 times you should consider rebalancing your portfolio
First, through a regular reviewing period, typically every three or six months. Anything more than monthly means you might spend too much on trading costs. Anything less than once a year risks allowing your portfolio to drift too far from your original strategy.
Second, you can choose to rebalance when the portfolio weights move too far from their target. For example, you might have a target of 60% invested in shares and 40% in bonds. If shares perform better than bonds, their weight will rise. You could choose to rebalance back to your target when the shares weight reached a limit of 3% above target, so 63% in our example.
There’s a trade-off between sticking close to your strategy and transaction costs. The closer you set the limit to the target weight, the more trading costs you’ll incur. The further you set the limit from the target, the more your portfolio will drift away from its targets. We think limits somewhere between 1% and 5% achieve the right balance. If your investments are held outside of an ISA or pension, you’ll need to think about any tax implications of your trades.
Lastly, if you’re regularly adding to or withdrawing from your portfolio, this is an ideal time to rebalance too.
If all the above seem too complicated, there’s a fourth option – buy a managed portfolio where the portfolio manager does the rebalancing for you.
Find out more about HL Ready-Made Investments
When is it right not to rebalance?
What if inflation proves more persistent than markets expect? What if the long-predicted recession finally arrives? Surely you then need a different strategy?
These are good questions to ask, but changing strategy means answering four of the most difficult questions in investing. What is the outlook for economies? What will this mean for stock markets? What has already been priced in? And how will I know when the consensus market view has caught up with mine?
No-one can accurately time the peaks and troughs in economies and markets. What’s more, if you have the confidence to follow a different strategy, it’s important to stick with one that’s consistent with your investment goals. And stay diversified to help shelter against the many risks that impact portfolios.
Regular rebalancing helps make sure your portfolio stays aligned to what you need and why you’re investing.
This article isn’t personal advice. If you’re not sure what’s right for your circumstances, our financial advisers can help. All investments can fall as well as rise in value, so you could get back less than you invest.
Editor's choice: our weekly email
Sign up to receive the week’s top investment stories from Hargreaves Lansdown
Please correct the following errors before you continue:
Hargreaves Lansdown PLC group companies will usually send you further information by post and/or email about our products and services. If you would prefer not to receive this, please do let us know. We will not sell or trade your personal data.