The Investment Board: What is Rebalancing?

The Investment Board: What does it mean to rebalance your investment portfolio? We explain

Holly Black 28 February, 2020 | 11:00AM
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Holly Black: Welcome to the Morningstar Investment Board. I'm Holly Black and today we are going to talk about rebalancing. What is rebalancing? I hear you cry. It's another investment word that's pretty jargony. But it is one that's worth knowing about.

So rebalancing is a piece of admin you perform on your investment portfolio once or twice a year. And the idea is you do a bit of tinkering to make sure it looks like you'd originally planned it to look and therefore, it will perform as you expect it to. Imagine, it's like leaving the kids in the front room while you go make dinner, you need to know they're going to sit there playing nicely, not wait till you're out the room, and then start beating each other up and throwing things out the window. Maybe that's quite extreme.

So, to illustrate this, let's think about an imaginary portfolio. We're going to just use a four-stock portfolio. Mostly because it's easiest for me to draw. So, I'm going to have £10,000 in my fake portfolio. And I'm going to split it equally across four funds. So, I get a nice pie. So, first 25% of my money is going in a UK fund. So that's £2,500 and then I'm going to add some to a global fund, same amount, I'm going to get a bit of income from my portfolio. So, I'm going to put a bond fund in here. And with my final 25%, I'm going to go a bit racy and put it in a tech fund.

So, while this isn't necessarily a diversified portfolio, and I wouldn't really say anyone should put 25% of their money in technology. What we do have is four equally sized fund positions accounting for £2,500 and 25% each of the money I have invested.

As time goes by, they're not all going to perform in exactly the same way because they hold different companies or assets, and they're driven by different things. So, if I come back to my portfolio a year later, it's going to look quite different.

So, let's imagine after a year, my UK fund has been hit by all the Brexit uncertainty, and it's down 50%, rubbish. On the other side of the coin, my tech fund has absolutely flown, it's up 100%, doubled my money, wicked. Maybe my global fund has got quite a lot of US in it so that's gone up 20%, it's now got £3,000. And my bond fund has just stayed flat, I've still got £2,500 in it maybe I took some income, but we didn't get any growth.

So, the value of my portfolio has changed over the years, I've made some money, because I'm a great investor and I've got £11,750. But because these have all performed differently, my pie is no longer equally sliced. In fact, tech is taking up 44% of my pie. The UK is just 10% tiny little sliver, global still about 25% and bonds have slipped down to 21%. This is not the portfolio I designed. And it does mean that I've now got a really risky investment portfolio. And if tech stocks start doing badly, I'm going to really suffer. Equally if the UK bounces back, we have the bonds bounce at the end of the year, then I'm not going to be able to benefit from that very well.

So, this is where rebalancing comes in. And rebalancing is about selling the winners and buying more for losers. So, we get back to the starting point. And that sounds really counterintuitive, because who wants to buy things that have been doing badly. That doesn't sound like much fun. And equally, I might be thinking what if this went up 100% last year, what if it does the same again, I might miss out. But you have to remember that's not the point of why you chose these investments. The point was, you chose them to be equal. So, they would deliver sort of some steady growth, not shoot the lights out and leave you overexposed to tech.

So, under my new amount that I have in my portfolio, what I need to do is sell and buy until I have the same amounts again, in each of my four funds. 25% in each and a nice even pie. And that's rebalancing.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Holly Black  is Senior Editor, Morningstar.co.uk