Imagine you’re driving to work after the weekend. You’re going a new route your colleague’s been raving about, but an unexpected traffic jam alert comes through on Google Maps. You’ve got options; follow the original directions and be late, take Google’s new suggested route, or pick a new one yourself.
Things change; it’s a fact of life. The important bit is how you react to these changes, if you react to them at all.
Whether it’s smaller day-to-day decisions about getting to work, or bigger plans to grow your wealth for your future, there will be times you stray from your plans and have to make choices to adjust to the new conditions. An example of this is rebalancing the assets in your portfolio.
What does rebalancing mean?
Rebalancing a portfolio means changing the composition of the investments within it to better reflect an investor’s risk level and the surrounding market conditions. In practice, investors use a series of trades to change the proportion of assets, or add and remove them from a portfolio.
For example, a less risk-averse investor has a £10,000 portfolio that’s split 70% equity and 30% bonds. After a particularly strong period for the equity market, the portfolio’s shares are up 10%, but a trickier bond market has caused its fixed income investments to fall 10%.
The portfolio has strayed from its target asset allocation is now split 74% equities and 26% bonds. The investor may choose to sell off some of its equity to buy more bonds and bring the portfolio back in line with its desired composition.
How to manage a portfolio
The continuous process of asset redistribution is crucial for strategic asset allocation – an approach that involves setting target portfolio allocations for each asset class based on an investor’s risk profile. But markets change and new opportunities come and go, which is when a tactical asset allocation strategy can really pay off.
Both approaches are intuitive; strategic asset allocation defines the long-term objectives of the portfolio, whilst the tactical element makes the most of any alternative options along the way – just like the example of the busy road.
Asset allocation isn’t easy. After deciding your risk tolerance, you need to outline your allocation targets to best reflect this, much like building blocks.
Then you need to construct a portfolio that builds in these investments after calculating their expected returns. All Moneyfarm portfolios have allocation targets that are consistent with each investor’s personal risk tolerance.
Rebalancing is as important to your financial wellness as your initial investment decisions when you first set up your portfolio. It’s a continuous process that shouldn’t be overlooked or rushed, but can get investors a step closer to reaching their financial goals.